Tag Archives: capital gains

Reducing Capital Gains: Step-up in Basis, The Basics

Dear Liza: My parents a house in 1995. They put the house in a trust in 1998 with me and my 2 brothers as beneficiaries. My dad passed away in 2007 and my mom in 2015. The house is now for sale . I’m not sure what the tax basis should be. That is a really good question, because, as I’m pretty sure you already know, the difference between the basis of the house and the sale price of the house will determine whether or not you and your 2 brothers are going to owe capital gains taxes on the sale of the house.

Just to review: capital gains taxes are due on the difference between an asset’s basis and its sale price. So, for example, if you buy a share of stock for $10/share and you sell that stock for $110/share, you would owe capital gains on that $100 of gain. Where I practice, in California, we estimate capital gains to be about 33% (federal top rate of 23.8%, plus 13.3% California top income tax rate), so you’d owe about $33/share, worse case scenario.

Assets that you inherit at death get what’s called a step-up in basis. If your mother, for example, had bought that same stock at $10/share, but hadn’t sold it during her lifetime, you and your brothers will inherit that stock at what it was worth the day she died. If that was $110/share, and you then sold those shares for $110/share, you’d owe no capital gains taxes at all.

Houses, like stocks, also receive a step-up in basis at death. But I can’t actually tell you what the basis in your mother’s house would be because I don’t know enough of the facts. The answer depends on what kind of living trust they had, and that also can depend on where they lived.

If your mother and father had a living trust that held the entire house in one revocable trust for your mother’s benefit, you and your siblings will inherit that house at its value on your mother’s date of death.  Since you are selling it two years after her death you need an appraisal to document its value on your mother’s date of death.  If you didn’t get one when she died, you can still get one that looks at the value in 2015, it will just cost more to get. That 2015 value will be your basis.

For example, if the house was appraised at $350,000 in 2015, and you are selling it for $450,000, you will have to pay capital gains on that $100,000 of gain.

If your mother and father, however, had what’s called an “A/B” trust, in which your father’s assets were placed in an irrevocable trust for your mother’s benefit (usually called a “Bypass Trust” or a “Credit Trust”), then the portion of the house held in that trust will not receive a second step up in basis at your mother’s death, and you’ll have to pay capital gains on the gain from 2007 until now.

For example, if, when your father died, the house was appraised at $200,000, and, as is common, half of the house was held in the Bypass Trust, and you are selling it now for $450,000, you are going to have to pay more in capital gains than you would if all of the house was in a revocable trust. Here’s how it works:

Half of the house was held in the Bypass Trust and has a basis of $100,000 (because the house was worth $ 200,000 in 2007, when your father died). Upon sale, that half of the house had a basis of $100,000 ($200,000/2) and realized $125,000 of gain ($225,000 – $100,000). The other half of the house, which was in your Mom’s revocable trust, gets a full step up, so has a basis of $175,000 ($350,000/2). That half of the house realized gain of $50,000 ($225,000-$175,000). So, you and your siblings will owe capital gains on $175,000 ($125,000 from your Dad’s trust plus $50,000 from your Mom’s trust).

As you can see, the kind of trust your parents had will greatly affect the capital gains taxes you and your brothers will owe upon sale. So, first step, figure out what kind of trust they had. Next step, consult with an accountant.

 

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).

Capital gains taxes on sale of house

Dear Liza: My daughter is on my deed as joint tenant with me.  If I die and she decides to sell the house,  will she have to pay capital gains taxes? When you die, your daughter will own the whole house, without having to go through probate.   If she then decides to sell the house, she will have to pay capital gains on the increase in value on the one-half of the house that she owned before your death.  The one-half of the house that she inherited from you will get a new tax basis for capital gains purposes, equal to the value of that one-half of the house when you died — this is called a ‘stepped-up’ basis.