Buying or selling a home can be one of the most important financial transactions in one’s life. Sale or other disposition of one’s home after death is often the most significant financial transaction in the distribution of a decedent’s estate. Tax consequences play an important role.
The biggest concern when selling property is usually capital gains taxes. A capital gain is the difference between the “basis” in property and its selling price. The basis is the purchase price of the property plus capital improvements, for example, a new roof or furnace or an addition to the home. So, if you purchased a house for $300,000, made $40,000 worth of capital improvements and sold it for $450,000 you would have $110,000 of gain ($450,000 – $300,000 – $40,000 = $110,000). States, not just the federal government, tax capital gains. In Pennsylvania, a fixed rate of 3.07% is levied. But as explained below, in many instances federal and state capital gains tax will not apply.
Couples who are married and file taxes jointly can sell their main residence and exclude up to $500,000 of the gain from the sale from their gross income. Single individuals can exclude only $250,000. Surviving spouses get the full $500,000 exclusion if they sell their house within two years of the date of the spouse’s death, and if other ownership and use requirements have been met. The result is that widows or widowers who sell within two years may not have to pay any capital gains tax on the sale of the home. Pennsylvania has an unlimited exemption under the same rule.
If it has been more than two years after the spouse’s death, the surviving spouse can exclude only $250,000 of capital gains on their federal income tax return. However, the surviving spouse does not automatically owe taxes on the rest of any gain.
When a property owner dies, the basis of the property is “stepped up.” This means the current value of the property becomes the basis. When a joint owner dies, half of the value of the property is stepped up. For example, suppose a husband and wife buy property for $200,000, and then the husband dies when the property has a fair market value of $300,000. The new basis (assuming no capital improvements) of the property for the wife will be $250,000 ($100,000 for the wife’s original 50 percent interest and $150,000 for the other half passed to her at the husband’s death). Higher tax basis means lower capital gains. In States other than Pennsylvania, that are “community property” States, property acquired during marriage is the community property of both spouses and the property’s entire basis is stepped up when one spouse dies.
Tax consequences form a significant part of estate and retirement planning. They also are an important consideration in long-term care asset protection planning. The attorneys at Vasiliadis Pappas Associates have guided many families in connection with minimizing and eliminating taxes related to acquisition and sale of real estate. Call us! We can help.
