Tax Implications of a (very) Appreciated House

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Typ997S
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Tax Implications of a (very) Appreciated House

Post by Typ997S » Mon Oct 22, 2018 6:22 pm

Hello - My 84 yr old Mother-in-Law owns a house worth approximately $2.5M. She and her husband (now deceased) were the original owners, ca. 1957 with a $20K purchase price. She does not have a large amount of liquid assets, the house is by far her dominant asset. I realize this is probably a question for an accountant, but I'm sure the wisdom of the BHs can help me. Here's two scenarios:

1) She sells the house to move into a smaller property or some sort of assisted living. I assume in this case she would owe capital gains tax on $2.5M - 20K, less the homeowner's exclusion. Is that correct?

2) She stays in the house until she dies, and her 2 heirs inherit the house. I assume that the cost basis steps up to $2.5M and the heirs would not owe any taxes if/when they sold the property.

Do I have this right? Any thoughts? Thanks!

lakpr
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Re: Tax Implications of a (very) Appreciated House

Post by lakpr » Mon Oct 22, 2018 6:31 pm

She’d owe capital gains on $2.5 million - $250K (single tax payer exclusion amount on sale of a primary residence) - $20K (original cost basis in the home) - cost of any upgrades done to the home.

(2) is correct.

Edited to add: sorry I think I made a mistake. Your mother in law inherited half the house when your father in law deceased. So her capital gains on the house would be $2.5 million - 0.5 * reasonable estimate of house worth when your father in law deceased - 250k exclusion
Last edited by lakpr on Mon Oct 22, 2018 6:35 pm, edited 1 time in total.

HEDGEFUNDIE
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Re: Tax Implications of a (very) Appreciated House

Post by HEDGEFUNDIE » Mon Oct 22, 2018 6:33 pm

lakpr wrote:
Mon Oct 22, 2018 6:31 pm
She’d owe capital gains on $2.5 million - $250K (single tax payer exclusion amount on sale of a primary residence) - $20K (original cost basis in the home) - cost of any upgrades done to the home.

(2) is correct.
Upgrades would have to be documented, and have to be upgrades, not regular maintenance/replacements, correct?

lakpr
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Re: Tax Implications of a (very) Appreciated House

Post by lakpr » Mon Oct 22, 2018 6:38 pm

HEDGEFUNDIE wrote:
Mon Oct 22, 2018 6:33 pm
Upgrades would have to be documented, and have to be upgrades, not regular maintenance/replacements, correct?
Correct. But see my edit above. If all upgrades were done prior to father in law deceased, then you don’t need to document them. Only any upgrades done after do need to be documented.

Frisco Kid
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Re: Tax Implications of a (very) Appreciated House

Post by Frisco Kid » Mon Oct 22, 2018 6:46 pm

California is a community property state, have been told that would mean your MIL receives a step up in basis upon her husbands death. Can others verify?

Topic Author
Typ997S
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Re: Tax Implications of a (very) Appreciated House

Post by Typ997S » Mon Oct 22, 2018 7:02 pm

"California is a community property state, have been told that would mean your MIL receives a step up in basis upon her husbands death. Can others verify?"

Thanks for pointing this out! I think you are correct, I found the following paragraph on marketwatch.com

"If you and your spouse owned one or more homes or other capital gain assets as community property in one of the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), the tax basis of the entire asset is stepped up to FMV (not just the half that belonged to your deceased spouse). This weird-but-true rule means you can sell assets inherited from your spouse and only owe federal capital gains tax on appreciation that occurs after your spouse’s death. (Source: Internal Revenue Code Section 1014(b)(6).)"

alan
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Re: Tax Implications of a (very) Appreciated House

Post by alan » Mon Oct 22, 2018 7:25 pm

Can any one comment on the tax implications of either getting a reverse mortgage or alternatively renting the house to generate the needed money to finance the assisted living .
Alan
ALAN

Carefreeap
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Re: Tax Implications of a (very) Appreciated House

Post by Carefreeap » Mon Oct 22, 2018 7:33 pm

Frisco Kid wrote:
Mon Oct 22, 2018 6:46 pm
California is a community property state, have been told that would mean your MIL receives a step up in basis upon her husbands death. Can others verify?
Probably but it will depend on how title is held.
Every day I can hike is a good day.

Gill
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Re: Tax Implications of a (very) Appreciated House

Post by Gill » Mon Oct 22, 2018 8:40 pm

alan wrote:
Mon Oct 22, 2018 7:25 pm
Can any one comment on the tax implications of either getting a reverse mortgage or alternatively renting the house to generate the needed money to finance the assisted living .
Alan
I don’t think either of these alternatives are more attractive than simply selling the house. It appears the capital gain problem may not exist in view of a likely new basis.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal

Northern Flicker
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Re: Tax Implications of a (very) Appreciated House

Post by Northern Flicker » Tue Oct 23, 2018 12:51 am

alan wrote:
Mon Oct 22, 2018 7:25 pm
Can any one comment on the tax implications of either getting a reverse mortgage or alternatively renting the house to generate the needed money to finance the assisted living .
Alan
With a reverse mortgage, the house must be sold and the mortgage paid off if the owner discontinues living in the house. This is probably not a good option. The OP should talk to a CPA to confirm current basis with any step up available from death of one spouse and to estimate tax liability. Once tax liability of a regular sale is estimated, alternative strategies can be evaluated properly.
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LilyFleur
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Re: Tax Implications of a (very) Appreciated House

Post by LilyFleur » Tue Oct 23, 2018 1:08 am

Assisted living and skilled nursing are quite expensive. You may want to wait to sell the house when she goes into one of those living situations that would be tax deductible. The last year of my mom's life had huge tax deductible expenses for her care--way more than her $24,000 annual social security income! So if you sold the house the same year she went into care, at least you would have a lot of medical tax deductions to help offset her capital gains. (Thanks to Susan Collins for making sure the medical tax deduction stayed in the new tax bill. It makes a huge difference for end-of-life care.)

From Intuit/TurboTax:
How do you determine what portion of assisted living is deductible and what is not? Is this provided by the facility?
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The real key is the amount that was for medical care, assisted living is not the same as nursing home care where there is no ability to care for ones self. The information below may help guide you to a determination. And this link may be useful: Tax Deductions for Assisted Living Costs

These are the basic rules concerning the tax deductibility of Assisted Living and Alzheimer's care expenses:

According to the 1996 Health Insurance Portability and Accountability Act (HIPAA), “long-term care services” may be tax deductible as an unreimbursed medical expense on Schedule A. Qualified long-term care services have been defined as including the type of daily “personal care services” provided to Assisted Living residents, such as help with bathing, dressing, continence care, eating and transferring, as well as “maintenance services”, such as meal preparation and household cleaning.
Assisted Living residents seeking tax deductions for their services must qualify as “chronically ill”. This definition refers to seniors who are unable to perform two or more “Activities of Daily Living” (eating, transferring, bathing, dressing and continence) without assistance, or who need constant supervision because of a “severe cognitive impairment” such as Alzheimer’s disease or related dementias. The Assisted Living resident must have been certified within the previous 12 months as “chronically ill” by a licensed health care practitioner.
In order to qualify for a deduction, personal care services must be provided pursuant to a plan of care prescribed by a licensed health care practitioner. Many Assisted Living communities have on staff a licensed nurse or social worker who prepares a plan of care, sometimes called a “Wellness Care Plan,” in coordination with the resident’s physician which outlines the specific daily services the resident will receive in the community.
In order to take advantage of deductions, a taxpayer must be entitled to itemize his or her deductions. Additionally, long-term care services and other unreimbursed medical expenses must exceed 7.5% of the taxpayer’s adjusted gross income. (Generally, a taxpayer can deduct the medical care expenses of his or her parent if the taxpayer provides more than 50% of the parent’s support costs.)

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FIREchief
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Re: Tax Implications of a (very) Appreciated House

Post by FIREchief » Tue Oct 23, 2018 1:56 am

LilyFleur wrote:
Tue Oct 23, 2018 1:08 am
So if you sold the house the same year she went into care, at least you would have a lot of medical tax deductions to help offset her capital gains.
We don't have enough information (i.e. when her husband died and what the value of the house was at that point), but we are thinking that if it was fairly recent, there will be zero taxable gains due to the 100% step up in community property states.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

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Typ997S
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Re: Tax Implications of a (very) Appreciated House

Post by Typ997S » Tue Oct 23, 2018 12:25 pm

FIREchief wrote:
Tue Oct 23, 2018 1:56 am
LilyFleur wrote:
Tue Oct 23, 2018 1:08 am
So if you sold the house the same year she went into care, at least you would have a lot of medical tax deductions to help offset her capital gains.
We don't have enough information (i.e. when her husband died and what the value of the house was at that point), but we are thinking that if it was fairly recent, there will be zero taxable gains due to the 100% step up in community property states.
OP here, with the rest of the numbers...Spouse died in 2003, when the house was worth about $1.2M, and $50K of improvements have been made since 2003. So with the $250K exclusion and $20K purchase price, we're left with a $1M taxable gain. At 15%, that's $150K. A fair amount of money to be sure, but "only" 6% of the value of the house. So while the tax implications will be a factor on whether to stay in the house, it's very likely that other factors (read: health) will drive the decision to stay in the house or sell.

Thanks to all for your inputs!

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FIREchief
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Re: Tax Implications of a (very) Appreciated House

Post by FIREchief » Tue Oct 23, 2018 1:47 pm

Probably a good time to remind folks that when a spouse dies, it's a good idea to get a formal appraisal of the house if there are no plans to immediately sell it.
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

Gill
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Re: Tax Implications of a (very) Appreciated House

Post by Gill » Tue Oct 23, 2018 2:10 pm

Typ997S wrote:
Tue Oct 23, 2018 12:25 pm
OP here, with the rest of the numbers...Spouse died in 2003, when the house was worth about $1.2M, and $50K of improvements have been made since 2003. So with the $250K exclusion and $20K purchase price, we're left with a $1M taxable gain. At 15%, that's $150K. A fair amount of money to be sure, but "only" 6% of the value of the house. So while the tax implications will be a factor on whether to stay in the house, it's very likely that other factors (read: health) will drive the decision to stay in the house or sell.

Thanks to all for your inputs!
You can't use the purchase price when you have the stepped up basis, but I realize that amount isn't really material here. You will also have selling expenses so your $1 million gain should be in the ballpark. I agree that the tax considerations should only be a minor factor in her situation.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal

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celia
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Re: Tax Implications of a (very) Appreciated House

Post by celia » Tue Oct 23, 2018 2:51 pm

Typ997S wrote:
Tue Oct 23, 2018 12:25 pm
OP here, with the rest of the numbers...Spouse died in 2003, when the house was worth about $1.2M, and $50K of improvements have been made since 2003. So with the $250K exclusion and $20K purchase price, we're left with a $1M taxable gain. At 15%, that's $150K. A fair amount of money to be sure, but "only" 6% of the value of the house. So while the tax implications will be a factor on whether to stay in the house, it's very likely that other factors (read: health) will drive the decision to stay in the house or sell.
Besides 6% going to pay capital gains taxes, you will likely have up to an additional 6% commission on the selling price when it sells, so that's another 6% or $150K.

However, you should read up on commissions and how much they are negotiable. This 2-year-old article in the LA TImes gives some thoughts regarding commissions. It doesn't seem like it should be much harder to sell a $2.5M house compared to a $1.0M house, so there should be lots of negotiating room here.

And if this house is in California, don't forget that if the heirs continue to own the house, they get to keep the old property tax.

MarkNYC
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Re: Tax Implications of a (very) Appreciated House

Post by MarkNYC » Tue Oct 23, 2018 3:06 pm

Typ997S wrote:
Tue Oct 23, 2018 12:25 pm
FIREchief wrote:
Tue Oct 23, 2018 1:56 am
LilyFleur wrote:
Tue Oct 23, 2018 1:08 am
So if you sold the house the same year she went into care, at least you would have a lot of medical tax deductions to help offset her capital gains.
We don't have enough information (i.e. when her husband died and what the value of the house was at that point), but we are thinking that if it was fairly recent, there will be zero taxable gains due to the 100% step up in community property states.
OP here, with the rest of the numbers...Spouse died in 2003, when the house was worth about $1.2M, and $50K of improvements have been made since 2003. So with the $250K exclusion and $20K purchase price, we're left with a $1M taxable gain. At 15%, that's $150K. A fair amount of money to be sure, but "only" 6% of the value of the house.
With a $1M taxable gain, approximately half the gain would be taxed at 20% rather than 15%. And most of the gain will also be subject to the 3.8% Net Investment Income Tax. And the full gain would also be subject to CA income tax. So total tax might be closer to $300K than $150K.

Gill
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Re: Tax Implications of a (very) Appreciated House

Post by Gill » Tue Oct 23, 2018 3:44 pm

One think that might be money well spent would be to obtain an appraisal of the house as of the date of death in 2003 if one hasn't been done already. Wouldn't hurt to point out to the appraiser that it is for the purpose of establishing basis as of that date. :wink:
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal

Carefreeap
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Re: Tax Implications of a (very) Appreciated House

Post by Carefreeap » Tue Oct 23, 2018 6:21 pm

Typ997S wrote:
Tue Oct 23, 2018 12:25 pm
FIREchief wrote:
Tue Oct 23, 2018 1:56 am
LilyFleur wrote:
Tue Oct 23, 2018 1:08 am
So if you sold the house the same year she went into care, at least you would have a lot of medical tax deductions to help offset her capital gains.
We don't have enough information (i.e. when her husband died and what the value of the house was at that point), but we are thinking that if it was fairly recent, there will be zero taxable gains due to the 100% step up in community property states.
OP here, with the rest of the numbers...Spouse died in 2003, when the house was worth about $1.2M, and $50K of improvements have been made since 2003. So with the $250K exclusion and $20K purchase price, we're left with a $1M taxable gain. At 15%, that's $150K. A fair amount of money to be sure, but "only" 6% of the value of the house. So while the tax implications will be a factor on whether to stay in the house, it's very likely that other factors (read: health) will drive the decision to stay in the house or sell.

Thanks to all for your inputs!
Be sure to talk to a CPA and discuss some options. Your big hit is going to be CA's income tax as it will tax the gain as ordinary income. When I sold my mother's condo to a well qualified friend I structured a carry back (installment sale) to spread the $300k gain over three years. It's not an option for everyone but worth considering especially if your mother could use the income.

Good luck with the sale.
Every day I can hike is a good day.

inbox788
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Re: Tax Implications of a (very) Appreciated House

Post by inbox788 » Tue Oct 23, 2018 6:25 pm

You may want to look into or discuss with a professional about whether Proposition 60/90 would be relevant to your situation and how to properly apply it.

https://www.boe.ca.gov/proptaxes/prop60-90_55over.htm
https://sherylfleming.com/RealtorWebPag ... 1579949412

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