Sale of a Residence After Death – Part I
Originally published in the Cedar Street Times
March 22, 2013
When a living individual sells a personal residence that results in a gain, many people are familiar with the rules which may allow an exclusion of the taxable gain of up to $250,000 ($500,000 if married filing joint) if the taxpayer lived in the property two out of the last five years as his or her primary residence. In the depressed real estate markets over the past few years, many people have also learned (sometimes to much dismay) that a loss on a personal residence is not deductible.
But what happens when a house is sold after someone passes away?
The first thing we need to do is determine the cost basis. At the date of death, the cost basis of the property changes to whatever the current fair market value (FMV) is (an appraisal is required – not a market analysis by a real estate agent). If the house is held in joint tenancy or tenancy in common, only the decedent’s share of the home gets a step up (or down) in basis to the current FMV, and the basis for the survivor’s original share does not change.
If, however, it is held as community property, the entire interest in the house gets a step in basis to the current FMV. If the property is held “with rights of survivorship” then the house passes immediately to the survivor which in turn inherits the new stepped up (or down) basis of the decedent to add to his or her own basis-in the case of joint tenancy or tenancy in common, or he or she takes the new FMV as the new basis if it was community property.
When the property is sold, the survivor reports the sales price less the new basis and selling expenses. If it was sold soon after death, the survivor often realizes a loss due to sales expenses if they got a full step-up in basis (albeit nondeductible if maintained as a personal residence). If the survivor realizes a gain, then, the survivor is eligible for the $250,000 exclusion assuming he or she meets all the normal rules. If it was a spouse that passed away, then the widow or widower would have two years from the date of death to sell the house and still be eligible for the $500,000 exclusion.
In two weeks we will discuss the more interesting scenarios that play out when the property is not held “with rights of survivorship” and the property goes to the individual’s estate or trust, such as is often the case at the death of a single individual or the death of the second spouse.
Remember, it is always best to seek competent advice as everybody’s tax situation is unique and there are more rules that could affect you than just those mentioned in this article.
Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Travis H. Long, CPA, Inc. Blog 
Travis, your blog is really timely. Your topic is exactly what my family has been going through with the sale of three properties in LA after my parents’ deaths. I always wondered why the calculation for capital gains on those properties was different than the recent calculation of capital gains on mine. You’ve explained it very well. Thanks greatly.
You are welcome, and thanks, again, Chris.
Travis..If you are buying out another heir on inherited property..would you determine FMV on date of death of last living parent? and my last question is ..if you wait a few years to do the buy out does that change the FMV buy out..blessings..Anna
Hi Anna. It depends on the purpose of determining the FMV. If you are thinking for establishing cost basis then it depends on the estate planning. If the estate planning of the first spouse included a traditional A/B split where the decedent’s assets went to a Bypass Trust, and to the extent the house went to the bypass trust (sometimes you have fractional ownership between the A and B trusts), there would be no second step-up/down in basis to the FMV at the death of the second parent. To the extent the house was not in the bypass trust, it would get a second step-up/down to the FMV at the date of the second parent’s death. If you are just talking about determining the FMV so you guys can divvy up the assets fairly to the heirs after the second parent passes, then you are likely going to wait until the proximate time of doing the division to determine the value. Sometimes we use date of death values if the distribution of assets occurs fairly quickly after death, but the longer the period of time, the more there is a chance the assets could go up or down while in administration. It is never going to be perfect, but you try to be fair given the circumstances. Sometimes specific assets are slated for certain beneficiaries by the estate planning documents, and then it doesn’t matter if those assets go up or down since they are already specifically allocated. You also have to take into consideration if other assets were already distributed. Maybe some benes received a chunk of their assets previously, so those assets have been growing in their hands, and if other benes hadn’t received their share and were waiting to buy out the house, then some of that growth should probably be theirs. It can get complicated. Thinking it all through ahead of time before distributing any assets is important. At the end of the day, you are trying to be reasonable and fair, otherwise, you could end up with a lawsuit on your hands.
Can a $250,000 capital gain be excluded under section 121 of a personal resident which became part of a Trust after the sole owner dies? In other words, does the section 121 exclusion stay available to the Trust beneficiaries when calculating the CG reported on Form 1041?
No. The beneficiaries do not meet the primary residence usage rules. Only a surviving spouse can claim the time of use of the decedent after death as allowed in Section 121(d)(2).
Another consideration for you is that typically the lack of the 121 exclusion is not a big problem after death as there is a generally a step-up in basis at the date of death. Plus you have sales commissions and other expenses to give you some additional gain protection as well. But if the person passed several years ago during the rapid housing appreciation, you might still have some tax issues.