Inheritance, Cap Gains Tax question

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Topic Author
steve.s
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Inheritance, Cap Gains Tax question

Post by steve.s »

I think I know the answer to this but would appreciate a confirmation.

Mother-in-law passed away in 2008 leaving an estate that consisted of her house and an investment account with multiple stocks and money market. The house was appraised for the estate and the stock value/prices are known. The estate was split equally between my wife and her sibling. The stocks were distributed in increments over several years (the probate lawyer's approach), and the house sold in 2013 for less than the appraised value. Final proceeds were distributed in 2013.

It is my understanding that both the stocks and house receive the "step up in basis" on the death of the owner (MIL). My wife has sold several of the stocks, some at gains, others at losses, in prior years and have noted the gains/losses on our Schedule D, using her mom's date of death as the basis date/value. She received the cash proceeds from the sale of the house in 2013 and is of the opinion that it is a cash distribution, with no basis, gain or loss, and therefore does not need to be documented on our Schedule D. I think the proceeds from the house are her share of the loss from the house sale, just like the gains/losses from the sale of some of the equities (and that we should use the basis of the equities on the date her mom passed, not the date received).

In a related question, what documentation should we expect on the sale of the house, and who should be responsible for providing it?

Any CPAs out there willing to offer unofficial guidance? Thanks

SS
sscritic
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Re: Inheritance, Cap Gains Tax question

Post by sscritic »

Was the house rented out between 2008 and 2013? While the date of death sets the basis, the use determines whether you can claim the loss. Just as you cannot claim a loss on your own home that you buy, you can't claim it on your own home that you inherit. That's my non-expert understanding.
Topic Author
steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

No, the house was occupied by my wife's sibling (who had never lived anywhere else) at no rent. He paid all the expenses for maintenance. Are you saying that my BIL can't take his share of the loss but we could?
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FNK
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Re: Inheritance, Cap Gains Tax question

Post by FNK »

My understanding is that your main home gets no cap gains or losses, but your second home is fair game.

I think calling the IRS is free and a lot safer than asking the folks here.
sscritic
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Re: Inheritance, Cap Gains Tax question

Post by sscritic »

I just called. :)

A second home is still a personal residence. If it is not rented, it is not being used in a trade or business.
Your second home (such as a vacation home) is considered a personal capital asset.
Generally, property held for personal use is a capital asset. Gain from a sale or exchange of that property is a capital gain. Loss from the sale or exchange of that property is not deductible.
A loss on the sale or exchange of personal use property, including a loss on the sale of your home used by you as your personal residence at the time of sale, is not deductible. Only losses associated with property used in a trade or business and investment property (stocks) are deductible.
pshonore
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Re: Inheritance, Cap Gains Tax question

Post by pshonore »

Here's what Pub 559 has to say on the matter
Sale of decedent's residence. If the estate is the legal owner of a decedent's residence and the personal representative sells it in the course of administration, the tax treatment of gain or loss depends on how the estate holds or uses the former residence. For example, if, as the personal representative, you intend to realize the value of the house through sale, the residence is a capital asset held for investment and gain or loss is capital gain or loss (which may be deductible). This is the case even though it was the decedent's personal residence and even if you did not rent it out. If, however, the house is not held for business or investment use (for example, if you intend to permit a beneficiary to live in the residence rent-free and then distribute it to the beneficiary to live in), and you later decide to sell the residence without first converting it to business or investment use, any gain is capital gain, but a loss is not deductible.
Certainly a gray area, bit it sounds like you get to deduct your portion of the loss but wife's sibling does not.
sscritic
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Re: Inheritance, Cap Gains Tax question

Post by sscritic »

pshonore wrote:Here's what Pub 559 has to say on the matter
Sale of decedent's residence. If the estate is the legal owner of a decedent's residence and the personal representative sells it in the course of administration, the tax treatment of gain or loss depends on how the estate holds or uses the former residence. For example, if, as the personal representative, you intend to realize the value of the house through sale, the residence is a capital asset held for investment and gain or loss is capital gain or loss (which may be deductible). This is the case even though it was the decedent's personal residence and even if you did not rent it out. If, however, the house is not held for business or investment use (for example, if you intend to permit a beneficiary to live in the residence rent-free and then distribute it to the beneficiary to live in), and you later decide to sell the residence without first converting it to business or investment use, any gain is capital gain, but a loss is not deductible.
Certainly a gray area, bit it sounds like you get to deduct your portion of the loss but wife's sibling does not.
They let a beneficiary live in it rent-free for five years. That sounds like intent to permit a beneficiary to live in the residence rent-free. That is not a business use.
livesoft
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Re: Inheritance, Cap Gains Tax question

Post by livesoft »

The stocks were distributed in increments over several years (the probate lawyer's approach), ...
So has the estate been in existence from 2008-2013? Was the probate lawyer filing tax returns for the the estate all those years? Were the heirs getting K-1s for all the dividends paid by the unsold stocks in the estate?

Who sold the house? The estate?
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Topic Author
steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

livesoft wrote:
The stocks were distributed in increments over several years (the probate lawyer's approach), ...
So has the estate been in existence from 2008-2013? Was the probate lawyer filing tax returns for the the estate all those years? Were the heirs getting K-1s for all the dividends paid by the unsold stocks in the estate?

Who sold the house? The estate?
Wow! Thanks for the responses. I'd been looking for which IRS pub (590) was applicable - I'll do some reading.

(a little background: BIL is not fiscally astute and was "anchored" to the house (he's 56 and has never lived anywhere else in his life). It took a GREAT deal of pushing by us and probate lawyer to get him moving on finding a new place. IMHO, the probate lawyer and his staff are saints and earned every penny working this estate. The good news is MIL achieved her goal of leaving him with a "roof over his head" and he wasn't burdened with a house he couldn't afford. BIL could not afford cost of major repairs needed or annual property taxes, and my wife didn't want co-ownership, so the house stayed an asset of the estate.)

To answer the questions posed here:
- The estate was in probate from 2008 until present (not sure probate is actually finished).
- The probate lawyer was filing tax returns for the estate for all those years. We heard from probate lawyer on the estate tax filing expense as motivation to BIL.
- Dividends on the stocks paid into a money market account that was part of the investment account. No K-1s were received for dividends received (were we supposed to??) while in the estate - I am guessing the estate paid the taxes on the dividends received (is this an issue?). When the stocks were formally distributed (in several increments under lawyer/court direction/supervision), the MM account was retained to pay estate expenses. As the estate came to closure, most of the MM was distributed. (This raises a new question - should my wife (a beneficiary) have been receiving copies of the estate's annual tax returns? Keep in mind that I'm the outsider here, but am obviously at risk if something wasn't done right)
- The house was sold by the estate in may 2013 and proceeds were distributed in September.

Sounds like I need to contact the probate lawyer and request some records in addition to the data on the house sale.
Hope my additional info clarifies the situation. You are starting to convince me that I need to turn this over to a pro for this year. Thanks for the info so far and for any forthcoming.

SS
Last edited by steve.s on Sun Jan 26, 2014 3:26 pm, edited 1 time in total.
Louis Winthorpe III
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Re: Inheritance, Cap Gains Tax question

Post by Louis Winthorpe III »

I'm curious -- why did the probate lawyer hold onto a portion of the stocks for such a long time? Five years seems unreasonable. Was there a financial incentive for him/her to drag the process out?
Topic Author
steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

Louis Winthorpe III wrote:I'm curious -- why did the probate lawyer hold onto a portion of the stocks for such a long time? Five years seems unreasonable. Was there a financial incentive for him/her to drag the process out?
The stocks were the only liquid asset and were retained to pay the expenses (property taxes, estate admin, etc) that needed to be paid.
The lawyer DID NOT drag the process out. BIL did, since he was resident in the house and he took a long time to a) find a place, and b) sort through his stuff (I won't bother to describe the state of the house/records/etc).
Topic Author
steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

FNK wrote:My understanding is that your main home gets no cap gains or losses, but your second home is fair game.

I think calling the IRS is free and a lot safer than asking the folks here.
I believe that you get an exemption on the first chunk (250K for a single/500K for married couple) of gain on your primary residence.
livesoft
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Re: Inheritance, Cap Gains Tax question

Post by livesoft »

steve.s wrote:IMHO, the probate lawyer and his staff are saints and earned every penny working this estate.
Perhaps so, but do you know how much the estate was charged every year? What if it was 5% per year? How much were those folks paid?
If they had sold all stocks and given them to heirs in 2009 and you invested the money, you would be sitting on a nice set of untaxed capital gains. Instead, it appears that lots and lots of taxes were probably needlessly paid. But nothing you can do about it now.
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2stepsbehind
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Re: Inheritance, Cap Gains Tax question

Post by 2stepsbehind »

livesoft wrote:
The stocks were distributed in increments over several years (the probate lawyer's approach), ...
So has the estate been in existence from 2008-2013? Was the probate lawyer filing tax returns for the the estate all those years? Were the heirs getting K-1s for all the dividends paid by the unsold stocks in the estate?
So livesoft's question and the OP's response spurred a question of my own. Are executors allowed to allocate/distribute capital gains to take advantage of certain beneficiaries' lower tax rates? In other words lets say after liquidation of certain stock the estate is worth 100k, 10k of which is capital gain. Assuming there are 2 beneficiaries who share alike under the will, but one is the 28% tax bracket, the in the 15% bracket, could the executor allocate all 10k of the capital gains to the beneficiary in the 15% bracket in order to take advantage of the 0% long term capital gains rate? Could strategies like this explain why the OP did not receive a K-1?
Topic Author
steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

livesoft wrote:
steve.s wrote:IMHO, the probate lawyer and his staff are saints and earned every penny working this estate.
Perhaps so, but do you know how much the estate was charged every year? What if it was 5% per year? How much were those folks paid?
If they had sold all stocks and given them to heirs in 2009 and you invested the money, you would be sitting on a nice set of untaxed capital gains. Instead, it appears that lots and lots of taxes were probably needlessly paid. But nothing you can do about it now.
None of this is germane to my initial question of if/how to handle the capital loss associated with the sale of the house.
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steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

2stepsbehind wrote:
livesoft wrote:
The stocks were distributed in increments over several years (the probate lawyer's approach), ...
So has the estate been in existence from 2008-2013? Was the probate lawyer filing tax returns for the the estate all those years? Were the heirs getting K-1s for all the dividends paid by the unsold stocks in the estate?
So livesoft's question and the OP's response spurred a question of my own. Are executors allowed to allocate/distribute capital gains to take advantage of certain beneficiaries' lower tax rates? In other words lets say after liquidation of certain stock the estate is worth 100k, 10k of which is capital gain. Assuming there are 2 beneficiaries who share alike under the will, but one is the 28% tax bracket, the in the 15% bracket, could the executor allocate all 10k of the capital gains to the beneficiary in the 15% bracket in order to take advantage of the 0% long term capital gains rate? Could strategies like this explain why the OP did not receive a K-1?
As far as I can tell, the estate, not the heirs, pays the taxes on capital gains that the estate receives (which would be the case if an equity held by the estate is sold before distribution to an heir (hmm, maybe that's the answer to my initial question?)) - at least that's what happened here and we haven't received any push-back from the IRS or the state. Every situation, in each state, is unique - your mileage may vary.

Again, while interesting to some, we've drifted off topic a bit (altho we may have actually identified the answer to my initial question here), so I think I'll suggest we end this discussion here. Thanks to the others who provided inputs/links to the IRS pubs. I'm taking this to a local CPA since it's obvious to me that this is above my knowledge.
MarkNYC
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Re: Inheritance, Cap Gains Tax question

Post by MarkNYC »

steve.s wrote:None of this is germane to my initial question of if/how to handle the capital loss associated with the sale of the house.
The house was owned by the estate and sold by the estate. The sale should be reported by the accountant for the estate on the estate income tax return Form 1041. Since a beneficiary was allowed to live in the house for 5 years after the decedent's death, I believe that eliminates the house as a capital asset (for loss purposes), and the loss should be shown as nondeductible on the 1041.

If the estate had other net income for the year, after expenses, that income will pass out to the beneficiaries along with the cash distribution each one received during the year. You should ask the accountant for the estate if you/your wife will receive a K-1 for this past year and if so, what amounts it is likely to show. For income tax purposes, many estates use a year-end other than December 31, so you should ask about that also.
2stepsbehind
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Re: Inheritance, Cap Gains Tax question

Post by 2stepsbehind »

steve.s wrote:
2stepsbehind wrote:
livesoft wrote:
The stocks were distributed in increments over several years (the probate lawyer's approach), ...
So has the estate been in existence from 2008-2013? Was the probate lawyer filing tax returns for the the estate all those years? Were the heirs getting K-1s for all the dividends paid by the unsold stocks in the estate?
So livesoft's question and the OP's response spurred a question of my own. Are executors allowed to allocate/distribute capital gains to take advantage of certain beneficiaries' lower tax rates? In other words lets say after liquidation of certain stock the estate is worth 100k, 10k of which is capital gain. Assuming there are 2 beneficiaries who share alike under the will, but one is the 28% tax bracket, the in the 15% bracket, could the executor allocate all 10k of the capital gains to the beneficiary in the 15% bracket in order to take advantage of the 0% long term capital gains rate? Could strategies like this explain why the OP did not receive a K-1?
As far as I can tell, the estate, not the heirs, pays the taxes on capital gains that the estate receives (which would be the case if an equity held by the estate is sold before distribution to an heir (hmm, maybe that's the answer to my initial question?)) - at least that's what happened here and we haven't received any push-back from the IRS or the state. Every situation, in each state, is unique - your mileage may vary.

Again, while interesting to some, we've drifted off topic a bit (altho we may have actually identified the answer to my initial question here), so I think I'll suggest we end this discussion here. Thanks to the others who provided inputs/links to the IRS pubs. I'm taking this to a local CPA since it's obvious to me that this is above my knowledge.
Just another example of the vagaries of the internet. I'd still like an answer to my question. Are executors allowed to allocate/distribute capital gains to take advantage of certain beneficiaries' lower tax rates?
Topic Author
steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

So livesoft's question and the OP's response spurred a question of my own. Are executors allowed to allocate/distribute capital gains to take advantage of certain beneficiaries' lower tax rates? In other words lets say after liquidation of certain stock the estate is worth 100k, 10k of which is capital gain. Assuming there are 2 beneficiaries who share alike under the will, but one is the 28% tax bracket, the in the 15% bracket, could the executor allocate all 10k of the capital gains to the beneficiary in the 15% bracket in order to take advantage of the 0% long term capital gains rate? Could strategies like this explain why the OP did not receive a K-1?[/quote]

As far as I can tell, the estate, not the heirs, pays the taxes on capital gains that the estate receives (which would be the case if an equity held by the estate is sold before distribution to an heir (hmm, maybe that's the answer to my initial question?)) - at least that's what happened here and we haven't received any push-back from the IRS or the state. Every situation, in each state, is unique - your mileage may vary.


Just another example of the vagaries of the internet. I'd still like an answer to my question. Are executors allowed to allocate/distribute capital gains to take advantage of certain beneficiaries' lower tax rates?[/quote]

I don't know the answer to your question - for the answer, I suggest you consult an estate tax pro.

(Sorry about losing the quotes when I edited the quote :oops: )
Iorek
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Re: Inheritance, Cap Gains Tax question

Post by Iorek »

MarkNYC wrote:
The house was owned by the estate and sold by the estate. The sale should be reported by the accountant for the estate on the estate income tax return Form 1041. Since a beneficiary was allowed to live in the house for 5 years after the decedent's death, I believe that eliminates the house as a capital asset (for loss purposes), and the loss should be shown as nondeductible on the 1041.

I dunno. I'm not in a position to provide any legal advice, but it seems to me if the estate always intended to get BIL out of the house, and it simply took 5 years to do so then there might well be a basis to take the position that the house is a capital asset. I think there are times when tax treatment depends on intent. Now whether you can establish intent on those facts might be another question, but certainly worth exploring with counsel.
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steve.s
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Re: Inheritance, Cap Gains Tax question

Post by steve.s »

MarkNYC wrote:
steve.s wrote:None of this is germane to my initial question of if/how to handle the capital loss associated with the sale of the house.
The house was owned by the estate and sold by the estate. The sale should be reported by the accountant for the estate on the estate income tax return Form 1041. Since a beneficiary was allowed to live in the house for 5 years after the decedent's death, I believe that eliminates the house as a capital asset (for loss purposes), and the loss should be shown as nondeductible on the 1041.

If the estate had other net income for the year, after expenses, that income will pass out to the beneficiaries along with the cash distribution each one received during the year. You should ask the accountant for the estate if you/your wife will receive a K-1 for this past year and if so, what amounts it is likely to show. For income tax purposes, many estates use a year-end other than December 31, so you should ask about that also.
Thanks for these inputs! I think I backed into realizing that the estate still held the house when it was sold and your description is probably what actually happened - which I plan to confirm with the lawyer tomorrow.
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