What is the Surviving Spouses Taxable Gain on Sale of Home?

Category: Tax Law and Planning

A very common question is: If my spouse dies and I sell the house, what is my cost basis? Cost basis is important because Purchase Price - Basis = Gain (which is the Amount subject to Capital Gains Tax). The except below from This old house: cost-basis riddle -- Newsday.com is an excellent example of answers to that question.

However, cost basis is not the only issue. Once the Amount subject to Capital Gains Tax is determined, the next question is "What exclusions to Capital Gains Tax are there?" Under Internal Revenue Code Section 121, a single person can exempt the first $250,000 of Gain from the sale of his or her residence from tax (assuming the person has resided in the house for at least 2 years). This doubles to $500,000 for married couples.

So, if a surviving spouse is ever looking to sell the residence (no matter when the deceased spouse died) the questions are:

1 - What is the surviving spouse's Cost Basis in the house (see the examples below to calculate); and
2 - Is this Gain less then the Section 121 exemption available (if so, no tax).

"Imagine Fred and Ethel buy a house in 1982 for $135,000. In 2005, Fred dies and Ethel inherits the house, now worth $550,000. To calculate her profit when she sells it, she subtracts what the house cost - her 'cost basis' - from the $550,000 sale price. Current law says Fred and Ethel each had a 50 percent ownership stake in the house. Her cost basis on her own half is $67,500 - half of the original $135,000 purchase price. But her cost basis on Fred's half is its market value at the time of his death - $275,000 (half of $550,000). Her total cost basis: $342,500.

But before 1977, the law presumed that the spouse who died first owned 100 percent of the house, says Alan E. Weiner, senior tax partner at Holtz Rubenstein Reminick in Melville. Unless the surviving spouse could refute the presumption, the house was included in the deceased spouse's estate and the survivor inherited it at its market value. (The husband, usually the first to die, was also usually the only working spouse. 'It's unclear how the law would work if the first to die was a wife who hadn't contributed to the purchase of the house,' Weiner notes.)

Let's say Fred and Ethel bought their house in 1960 for $17,000. When Fred died in 2005, it was worth $450,000. Under the pre-1977 law, the entire $450,000 is included in his estate. No additional estate tax is due, however, because spouses inherit from each other tax-free. Ethel has inherited 100 percent of the house; her cost basis is $450,000.

The IRS says the old law still applies in cases involving marital joint property acquired before Jan. 1, 1977. It has said it will no longer litigate such cases. (For more details, go to www.irs.gov/pub/ir"

The Cost of Gifting Your Home

Category: Elder Law, Estate Planning, Tax Law and Planning

This brief article from mortgage101.com outlines why there may be a large cost of making a gift of your home to your children now, instead of continuing to live in it an bequeathing it to your children at your death.

"First and foremost, your child or friend's basis in the house will be what you paid for the property, plus major improvements. Because this cost you paid years ago is probably much lower than today's soaring home value, there's a chance tax will be owed on a subsequent sale.

For example, if you purchased your home in 1970 for $60,000 and it is now worth $450,000, your child's basis would be $60,000 if you chose to transfer the home to the child as a gift. If the married child sells the home 10 years down the road for $760,000, their tax liability would be on $200,000 ($760,000 minus the $60,000 basis, minus the $500,000 exclusion for married couples). Taxpayers in the 15 percent tax bracket would thus owe the Internal Revenue Service approximately $30,000 in capital gains tax."

BUT BE AWARE:

If the child did not live in the house, there would not be a "$500,000 exclusion for married couples" as outlined above. That only applies if the child and his or her spouse lived in the house for 2 years or more before sale. If you gifted the house to a child and you continued to live there, upon sale the child's basis would only be $60,000, leaving $700,000 subject to capital gain.

Also, while the federal capital gain tax rate is generally 15%, the state may have an additional capital gain rate. For example, in New Jersey, the capital gain rate is 7 1/2%, bringing the total combined capital gains tax rate to 22 1/2%, which on a $700,000 sale would be $157,500 - not chump change.

TWO ITEMS OF NOTE:

First, for Medicaid planning it may be worth the potential capital gains tax cost to remove the asset from your "available assets" so that the house does not have to be sold to provide for your long term care.

Second, it is possible to gift part of the house now, and keep enough of it to get a "step-up in basis" at your death. For example, if you give away the house, but retain the right to live there during your lifetime (a "life estate"), then the house will be part of your taxable estate. This means that your children's basis in the house upon your death would be the date of death value, $760,000 in the above example. Thus, if the children sold the house for $760,000, there would be no capital gain. But beware of the trap that keeping the asset in your taxable estate may cause an estate tax issue (New Jersey's estate tax exemption is only $675,000) just to avoid a capital gains tax issue. (A last point that here the NJ estate tax rates, which range up to 16% on amounts over $675,000 would be far less then the combined federal and state capital gains rates of 22.5% on $700,000 of gain.)

Can't Pay Your Taxes? Ignoring it is NOT the Answer

Category: Tax Law and Planning

We talked about what happens if you aren't ready to file by April 15th (17th this year), but what if you can't pay your taxes?

Don't ignore your tax obligation - it won't go away. In fact, it will just get larger, with the addition of interest and penalties.

The penalties for failure to file are seperate from the penalties for failure to pay. So even if you can't pay, you should file your return (or an extension as discussed earlier this week in _---) and address the payment issues seperately.

From Rubin on Tax: WHAT IF YOU CAN'T PAY YOUR INCOME TAXES BY APRIL 17?: "Here are some ideas to avoid the penalties (and interest, if the tax can be paid):

a. Borrow the tax payment from friends or family.

b. Bank loans (including home equity loans).

c. Credit card payment (where allowable by the credit card issuer). However, these providers charge a 2.49% fee, plus their usual interest.

d. Request an installment payment agreement from the IRS (using Form 9465). There is a $43 fee for these agreements. Interest is still charged on the unpaid tax, but the late payment penalty is reduced by 50% if the return is filed by the due date (including extensions).

e. Possible qualification for a 120 day extension to pay, or a payroll deduction installment agreement with the IRS. "

Extension of Time to File Your Tax Return (You Still Have to Pay

Category: Tax Law and Planning

The clock is ticking towards April 15th (actually, April 17th this year). If you haven't filed your tax return by now, you may want to consider the reality that you won't be able to file it on-time at all. To avoid the stress and headaches of last minute filing (and the long lines at the post-office) you may want to consider filing an Extension of Time to File. You can get an automatic 6-month Extension of Time to File by completing a Form 4868.

This is NOT a reprieve from paying your taxes - those must still be paid on or before April 17 to avoid interest and penalties.

For more information look at Extension of Time to File Your Tax Return from www.irs.gov:



Extension of Time to File Your Tax Return

Need more time to prepare your federal tax return? This page provides information on how to apply for an extension of time to file.

Please be aware that an extension of time to file your return does not grant you any extension of time to pay your tax liability.

Extensions for Individuals
If you are not able to file your federal individual income tax return by the due date, you may be able to get an automatic 6-month extension of time to file. To do so, you must file Form 4868, Application for Automatic Extension of Time To File U.S. Income Tax Return (51K) Adobe PDF, by the due date for filing your calendar year return (usually April 15) or fiscal year return. This form is also available en español.


Special rules may apply if you are:
living outside the United States
out of the country when your 6-month extension expires, or
serving in a combat zone or a qualified hazardous duty area.


You can also go to Filing Information in Publication 17, Your Federal Income Tax (HTML page), for more information regarding the rules for automatic extensions and filing federal individual income tax returns."