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Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 1:02 pm
by cowdogman
My wife's dad died in January of this year. Her mother had passed away earlier. Her dad left his house and most of the remainder of the estate to my wife and her two brothers (split equally). He owned the house himself, free of mortgage.

The house was listed with a broker by the estate and sold to an unrelated third party by the estate in July this year for (rounding slightly) $500,000, which was (based on my Zillow-type research, but not an appraisal) a fair market price. The house was never used as a personal residence or rented out since my father-in-law's death. There were some minor clean-up and repair costs, but there were no capital improvements to the house before sale. The estate assets were distributed recently.

My questions:

Given that the house was sold relatively soon after my father-in-law's death, I believe the proper/safe tax (stepped up) basis for the house for tax purposes is the actual gross sale price (S500,000) and that a capital loss will be generated once the sale costs are taken into account. Is that right?

What sale costs are taken into account? Just the usual ones like commissions, title insurance, escrow. other closing costs plus cost of repairs? What about the costs of maintaining the house during the during the clean-up/sale process--e.g., real estate taxes, utilities, yard maintenance, etc.

I believe the way the above is reported is by an IRS 1041 (tax return for the estate) and then the issuance of K-1s to the estate beneficiaries showing each beneficiary's share of the capital loss. The K-1s are then reported on each beneficiary's 1040. Is that right?

Will this be relevant to my wife's and my taxes for 2019 or 2020?

I was able to piece most of the above together from various posts in this forum (and thank you for that), but wanted to put all into one post for confirmation.

I should also note there is no disagreement among the siblings on any of the above. I'm just trying to figure out the how this will work for my wife's and my taxes.

Thanks.

Re: Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 1:25 pm
by 557880yvi
Following, my sister inherited a house (in its entirety so not split with anyone else) late 2018 and it was sold in Aug 2019. This is research I did for her on establishing the capital gains taxes/(loss).

FMV for Basis:

The basis of an inherited home is generally the Fair Market Value (FMV) of the property at the date of the individual's death. If no appraisal was done at that time, you will need to engage the help of a real estate professional to provide the FMV for you. There is no other way to determine your basis for the property.

IRS Publication on Property Cost Basis

https://www.irs.gov/forms-pubs/about-publication-551

https://www.investopedia.com/ask/answer ... -asset.asp

https://www.investopedia.com/terms/i/inheritance.asp

https://www.nolo.com/legal-encyclopedia ... usion.html


It is likely if the transaction was very close the passing of the owner, the real estate market in that geographic are was stable at the time of the sale and the sale was "arms-length" then the selling price could be evidence of FMV. However, if IRS questions the return and gain/(loss) - probably more likely if a loss - an appraisal by a licensed appraiser is a more substantive. Real Estate markets in certain areas have skyrocketed in just months were this house was sold and even a 6-month difference could result in lower FMV 6 months earlier at time of death. I have advised my sister to get a professional appraisal to support her return (her real estate agent gave her some information but it was poorly prepared and would not be adequate in an IRS audit). Appraisals are not expensive generally, $350-$400 average here in the Northeast.

Re: Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 2:42 pm
by cowdogman
557880yvi wrote:
Wed Oct 09, 2019 1:25 pm
It is likely if the transaction was very close the passing of the owner, the real estate market in that geographic are was stable at the time of the sale and the sale was "arms-length" then the selling price could be evidence of FMV. However, if IRS questions the return and gain/(loss) - probably more likely if a loss - an appraisal by a licensed appraiser is a more substantive.
Agreed that an appraisal is more substantive/persuasive. Zillow reports that for the relevant market (Chicago metro/suburbs) the average house price rose from $224,000 to $225,000 during the relevant period (January thru August)--so, essentially no increase. And I suspect if Chicago metro is excluded the average price would have actually dropped. The market did seem to soften during the listing. So maybe the appraisal would be beneficial--increase the loss?

Re: Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 4:14 pm
by bob60014
cowdogman wrote:
Wed Oct 09, 2019 2:42 pm
557880yvi wrote:
Wed Oct 09, 2019 1:25 pm
It is likely if the transaction was very close the passing of the owner, the real estate market in that geographic are was stable at the time of the sale and the sale was "arms-length" then the selling price could be evidence of FMV. However, if IRS questions the return and gain/(loss) - probably more likely if a loss - an appraisal by a licensed appraiser is a more substantive.
Agreed that an appraisal is more substantive/persuasive. Zillow reports that for the relevant market (Chicago metro/suburbs) the average house price rose from $224,000 to $225,000 during the relevant period (January thru August)--so, essentially no increase. And I suspect if Chicago metro is excluded the average price would have actually dropped. The market did seem to soften during the listing. So maybe the appraisal would be beneficial--increase the loss?
The real estate market for the Chicago metro area is quite variable. Some areas are very hot others, very cold and many areas haven't recovered from the real estate crash. Get the actual appraisal.

Re: Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 6:11 pm
by Gill
I disagree about the appraisal. The best indication of FMV is an arm’s length sale within a reasonable time after DOD. Use the sales price as your stepped up basis. Don’t waste your money on an appraisal.
Gill

Re: Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 8:29 pm
by 557880yvi
Gill wrote:
Wed Oct 09, 2019 6:11 pm
I disagree about the appraisal. The best indication of FMV is an arm’s length sale within a reasonable time after DOD. Use the sales price as your stepped up basis. Don’t waste your money on an appraisal.
Gill
The key is "reasonable time" - the IRS does not define this - and how much change there has been in the market between the date of death (or date of transfer of ownership) and the sale. The IRS allows you to choose a date 6 months from the date of death if the valuation had dropped since death or transfer.

The market in which my sister sold the house she inherited has increased dramatically (10% plus) since 2018 with bidding wars (this house sold for $25k over asking price and it is a tear-down) So the IRS knows this and to use the selling price as FMV in a time of quickly rising values 9 months after the death of the owner could risk inviting an audit. So one has to take into account the facts around the sale. The accounting firm preparing the estate returns recommended an appraisal as the cost would far less than any penalties, interest additional taxes. In her case, using the FMV would generate a significant tax loss (and carryforward) after deducting the commission and expenses over the 9 months and would likely be flagged by the IRS for review.

Re: Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 8:47 pm
by Geologist
557880yvi wrote:
Wed Oct 09, 2019 8:29 pm
Gill wrote:
Wed Oct 09, 2019 6:11 pm
I disagree about the appraisal. The best indication of FMV is an arm’s length sale within a reasonable time after DOD. Use the sales price as your stepped up basis. Don’t waste your money on an appraisal.
Gill
The key is "reasonable time" - the IRS does not define this - and how much change there has been in the market between the date of death (or date of transfer of ownership) and the sale. The IRS allows you to choose a date 6 months from the date of death if the valuation had dropped since death or transfer.
You need to be careful about suggesting the 6 month alternate valuation date. It is only possible if a number of criteria are met, one of which is that choosing this date reduces the amount of federal estate tax owed. If the estate pays no federal estate taxes (and most don't), then the alternate date (6 months after the date of death) cannot be used.

Re: Capital Loss on Sale of Inherited House

Posted: Wed Oct 09, 2019 9:14 pm
by Watty
cowdogman wrote:
Wed Oct 09, 2019 1:02 pm
I'm just trying to figure out the how this will work for my wife's and my taxes.
I am not a tax pro but the way that it worked when we were settling my Mom's estate and selling her house was that we had an accountant do her final tax returns.

She gave each of the siblings the required tax forms and explicit instructions on how to enter the numbers their individual tax returns. The instructions were literally "put this number on this line of your tax return". I forget the details but it was very easy to do and to understand where the numbers came from. I normally do my own taxes and with her instructions I still felt confident enough to do my own taxes that year.

Trying to understand what is going on is great but if the estate was significant I would suggest having the estate tax returns professionally done in case you were thinking of doing them yourself.

Re: Capital Loss on Sale of Inherited House

Posted: Thu Oct 10, 2019 9:44 am
by cowdogman
Watty wrote:
Wed Oct 09, 2019 9:14 pm
Trying to understand what is going on is great but if the estate was significant I would suggest having the estate tax returns professionally done in case you were thinking of doing them yourself.
Thanks. Yes, the estate taxes are being done by an accountant, but probably not for a few months yet. I'm just trying to figure out how things should work, so that I'm not surprised later. We're all learning as we go here.

On the appraisal issue, my guess is that if an appraisal is done it will result in an amount higher than the sale price (for a few reasons, including that I do think the market softened during the listing--e.g., competing houses in the same neighborhood were dropping their prices). If so, then we would have the choice of using the appraisal or the actual sales price. If we were worried about audits, the actual sale price would be the safe way to go. If the appraisal were lower than the actual sales price, we would, I think, need to go with the appraisal. So, in dollar terms, going the appraisal route has no potential upside and some potential downside.

On the general issue of audits, I'm sure some sellers game the system (reducing gains, increasing losses) in these situations, and I don't see why the IRS would target capital losses any more than capital gains.

Re: Capital Loss on Sale of Inherited House

Posted: Thu Oct 10, 2019 10:01 am
by 557880yvi
cowdogman wrote:
Thu Oct 10, 2019 9:44 am
Watty wrote:
Wed Oct 09, 2019 9:14 pm
I don't see why the IRS would target capital losses any more than capital gains.
Because you PAY taxes on gains. Losses REDUCE taxes. So there is incentive to manufacture losses that don't exist so they look for these situations.

Re: Capital Loss on Sale of Inherited House

Posted: Thu Oct 10, 2019 10:13 am
by NotWhoYouThink
Watty wrote:
Wed Oct 09, 2019 9:14 pm
cowdogman wrote:
Wed Oct 09, 2019 1:02 pm
I'm just trying to figure out the how this will work for my wife's and my taxes.
I am not a tax pro but the way that it worked when we were settling my Mom's estate and selling her house was that we had an accountant do her final tax returns.

She gave each of the siblings the required tax forms and explicit instructions on how to enter the numbers their individual tax returns. The instructions were literally "put this number on this line of your tax return". I forget the details but it was very easy to do and to understand where the numbers came from. I normally do my own taxes and with her instructions I still felt confident enough to do my own taxes that year.

Trying to understand what is going on is great but if the estate was significant I would suggest having the estate tax returns professionally done in case you were thinking of doing them yourself.
That's how I worked for my FIL's estate, too. The CPA that had done his taxes and the executor's taxes in years past did not know what she was doing with the 1041, and failed to take deductions she should have taken, resulting in a tax bill to us. Completely botched.

In order to fix it, I would have had to have been able to convince the executor (who knows less about taxes than I know about the rules of cricket) that the form was done improperly, and why I knew that, and why he should either have her do it over or pay someone else to do it. Since it was a 4 figure tax bill and not a 5 figure tax bill I decided that it wasn't worth the fight, which I would have probably lost anyway along with the family relationship.

Good luck.

Re: Capital Loss on Sale of Inherited House

Posted: Thu Oct 10, 2019 10:44 am
by cowdogman
557880yvi wrote:
Thu Oct 10, 2019 10:01 am

Because you PAY taxes on gains. Losses REDUCE taxes. So there is incentive to manufacture losses that don't exist so they look for these situations.
Whether a taxpayer games the system and either reduces capital gains or increases capital losses, the net result is the same to the IRS--less taxes paid.