What if a husband and wife own a home together that is worth $500,000 more? When one spouse dies and the other owns the property, do they get a basis increase? Or do they only get a $250,000 capital gains exemption when the property is sold?
-Samuel
Your question addresses the rules surrounding both the upgrade based on inherited assets and the capital gains exclusion on Sale of primary residence. These rules are independent of each other, so they are both true: the surviving spouse essentially receives a promotion and They only get an exemption of $250,000. This may seem a little confusing, so let’s break it down below.
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In finance, “basis” generally refers to the amount you pay for something. The basis is important because it is the starting point from which taxable gains are calculated. For example, let’s say you bought something for $100,000 – that’s your basis. If the value of the asset rises to $150,000 and you decide to sell it, you will owe taxes on the $50,000 capital gain.
A Basically a step Occurs when the basis of an inherited asset is reset to its market value at the time of the original owner’s (or co-owner’s) death. In other words, when a person inherits assets such as stocks or real estate, the tax basis is adjusted to reflect the value of the asset at the time of the owner’s death, rather than the amount initially paid for it.
Going back to the example above, let’s say you have an asset worth $100,000, and by the time you die, its value has increased to $150,000. Instead of inheriting your original basis, your heir gets a “stepped up” basis. In this case, their new basis is $150,000, and they will only make a profit if the value of the property increases further.
(Basis increase accounting is an important component of tax and estate planning. A Financial advisor People with experience in either field may be able to help you exploit this tax loophole.)
Section 121 of the Tax Code provides an exemption from capital gains tax up to $500,000.
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The tax code allows you to reduce or avoid capital gains tax on the sale of a primary residence, provided you have lived in it for two of the previous five years. This tax break is known as Article 121 Exception.
There are parameters you need to stay within to qualify for this tax break, but the general limits are as follows:
Individuals can exclude up to $250,000 of gain from the sale of a primary residence
Married couples filing a joint return can exclude up to $500,000 from the sale of the primary residence.
So, assume your home’s principal is $300,000. If you’re single, you can sell it for up to $550,000 without incurring a capital gains tax liability. The couple can sell it for up to $750,000. This example ignores transaction costs to provide a simplified illustration. You’ll need to work closely with your tax professional to make sure your basis is calculated correctly. (And if you need help finding a financial professional, This free tool They can connect you with three credit counselors serving your area.)
Samuel, to know how to apply both rules in the situation you’re asking about, we need to think about them in order:
First, determine the rising basis
Second, calculate the taxable profit taking into account the Section 121 exclusion
The surviving spouse receives an increase in basis upon the death of the first spouse. However, the value of this modification depends on whether they live in a community property state. In a Community ownership statethe surviving spouse essentially receives a full upgrade. This means that its basis becomes the fair market value of the asset at the time of the spouse’s death.
In the case of non-community (common law) property, the surviving spouse only receives a basis increase of half the value of the property. For example, a married couple’s joint basis is $300,000 but the house is worth $500,000 when the first spouse dies. Half of this $200,000 gain is added to the surviving spouse’s basis so that he or she has a basis of $400,000 on a home worth $500,000.
After the surviving spouse determines the step-up basis of the inherited home, they can then calculate the amount of taxable gain if they sell the property. And remember, they are only debtors Capital gains tax On the portion of that profit that exceeds the Section 121 exception.
Here’s one last example to tie it all together:
A couple living in a community property state owns a home worth $500,000 after they originally paid $300,000 for it. The first spouse dies and the surviving spouse’s tax basis is raised to $500,000. The surviving spouse can then sell the home for up to $750,000 without recognizing a taxable gain because of the $250,000 exclusion.
One last bit of nuance here: The exclusion amount depends on Tax filing status. “Married filing jointly” status receives a $500,000 exclusion while “Single” status receives a $250,000 exclusion. Widows and widowers are allowed to maintain their married status jointly in the year of death. Therefore, the surviving spouse may still be able to exclude the entire $500,000 if they sell the property in the same calendar year in which their spouse died. (But if you need additional help with your tax strategy, consider working with an… Financial advisor With tax experience.)
A senior couple is reviewing the escalation rules accordingly.
When one spouse dies and the surviving spouse decides what to do with their jointly owned home, it is important to understand the rules of stepped-up basis and capital gains tax exclusion. The surviving spouse will receive a step-up basis that can adjust the inherited home to its fair market value at the time of the spouse’s death. And if they want to sell it, they can still apply the Section 121 exception and avoid paying taxes on up to $250,000 in capital gains — and in some cases, $500,000 — on the home sale.
If possible, consider delaying selling appreciated investments until they reach a lower level Income tax bracketLike after retirement. Long-term capital gains are taxed more favorably, and if your income is low enough, you may qualify for a 0% capital gains tax rate. To find out how much you might owe when you sell your assets, try our services Capital gains tax calculator.
A financial advisor with tax and/or financial planning experience can help you determine the best time to sell assets to minimize the tax implications of the sale. Find a financial advisor It doesn’t have to be difficult. Free SmartAsset tool Matches you with up to three vetted financial advisors who serve your area, and you can make a free introductory call with your Match Advisors to determine who you feel is a good fit for you. If you’re ready to find an advisor who can help you achieve your financial goals, Start now.
Keep an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that is not at risk of significant fluctuations such as the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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Brandon Renfro, CFP®, is a financial planning columnist for SmartAsset and answers reader questions on personal finance and tax topics. Do you have a question you want answered? Email [email protected] and your question may be answered in a future column.
Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article.Some reader-submitted questions are edited for clarity or brevity.
