Susan recently lost her husband, Carl, and is now a widow. They shared ownership of their home with the right of survivorship. In simpler terms, this means that upon the death of Carl (co-owner), the surviving co-owner (Susan) automatically acquires full possession of the highly appreciated home.
Susan is unsure if she should sell it now and move to where her son lives, wait a few years to sell or stay put, in which case the house would eventually pass to her heirs.
She is curious about the tax consequences of her options. She must first understand the tax breaks available to individuals who sell their primary residences.
Exclusions
The law permits "exclusions" that let sellers avoid paying income taxes on the majority of their profits when they sell their primary residences. The profit exclusions are up to $500K for couples who file jointly, and as much as $250K for individuals. All sellers are liable for gains that exceed $500,000 or $250,00, respectively.
Susan chooses to sell her home.
Can she exclude $500K or $250K? The solution depends on the sale date and whether she marries again. Although no longer married, Susan is still eligible for the $500K as long as she sells within two years of Carl’s passing. If she sells after the two-year window, she is only eligible for $250K.
Susan remarries.
If her new spouse, George, lives in her home as his primary residence for at least two years out of the five years prior to the sale date, the exclusion will revert to $500K again.
Typically, the seller must have owned the home for those two years. George doesn’t fit those criteria. His name doesn’t have to appear on the title.
Additionally, according to the IRS, Susan and George don't have to be wed for the entire two years prior to the sale date, but they do need to be married, even if their wedding takes place just one day before the transaction.
Susan's taxable gain might be less than she anticipates even if she doesn't get remarried and doesn't sell her home within two years of Carl's death. It is likely that Susan owes taxes on the gain because her long-term capital gain on the sale of her home exceeds the exclusion limit.
Tax rates for long-term capital gains.
The tax rate is usually 15% for most sales, rising to 20% for many high-income sellers. When combined with the Medicare surtax of up to 3.8% on certain types of income, such as earnings from home sales, it can reach a maximum of 23.8% for people in the top income tax bracket of 37%.
- State income taxes may also be owed.
Tax Cuts and Jobs Act
State and local income and property tax write-offs were limited by the tax cuts and jobs act to $10,000. Another issue is that if Susan is subject to the alternative minimum tax, she loses any write-offs for state income taxes.
Step-up in basis
The government offers condolence gifts for bereaved people who sell inherited homes, securities, and other assets that have increased in value. According to tax terminology, the basis (the starting point for measuring loss or gain) of inherited assets "steps up" from their initial basis (typically the cost at the time of purchase), to their value on the date of death.
When Susan sells her home after Carl dies, she will gain from a step-up in basis. What if she never sells it? Upon Susan’s death, there’s a second step-up in basis that benefits her living heirs.
Only Carl has a partial interest in the first advancement. His adjusted basis is raised to the value of that half-interest at the time of his death, which is normally equal to half the original purchase price and half the cost of any later house modifications. If the couple had resided in a state with common property, the step-up would apply to the entire basis.
When Susan dies, there is a step-up in her adjustment which was previously increased by the step-up for Carl's half interest, to the value of the entire house when she dies. When the heir sells it, they are liable for capital gains taxes only on the post-inheritance appreciation.
The bottom line
A sale by her heirs greatly reduces or even eliminates those taxes, in comparison to Susan’s sale of the home, whose value has increased significantly. Susan, as well as those in comparable situations, should consult with a tax and estate planning attorney to be sure they're choosing the right course of action for their long-term future goals.
