Capital Gains Taxes on Appreciated Property

houseDear Liza: My mother gave her house to my sister just before she passed away.  My sister is going to sell the house. Do we have to pay taxes on that? If your mother’s house had appreciated in value between the time your mother purchased it, and her death, then the answer is yes. I can’t answer even a fraction of the questions that people send to me, so I try to pick ones that I think will have value to many people. Your sister is going to owe capital gains taxes on the difference between what your mother paid for that house and what your sister sells it for. Capital gains taxes are levied on the difference between what someone paid for an asset (that’s called the basis) and what they sell that asset for later (they’re taxed on the gain, or difference between the basis and the sale price.)

Because your mother gave the house to your sister before her death, your sister received that gift with your mother’s original tax basis. For example, if your mother purchased her house in 1976 for  $65,000, and your sister sells it in 2015 for $365,000, your sister is going to owe capital gains on the $300,000 in value that the house gained between 1976 and 2015. (There’s a $250,000 exclusion from this tax for the sale of a primary residence if you’ve lived there for 2 of the last 5 years, but I don’t know if that applies to your mother’s house here. It could, I suppose.)

If your mother had instead gifted that house to your sister upon her death, via a Will or a trust, your sister would have inherited it with a stepped-up basis, which means that her basis in that house would have been the value the house had at your mother’s date of death. In the example I just used, if your sister inherited the house with a value of $365,000 (as shown by a qualified appraisal) and then sold that house for $365,000, she would have owed zero in capital gains taxes. That’s the difference between lifetime gifts (donor’s basis) and gifts made as a result of death (date of death value basis).