Question: My father passed away December 2002.  All his assets were in a living trust.  Included was his primary residence. We sold his primary residence six months later (June 2003).  I know that our cost basis is fair market value on the date of death, but how exactly can this be determined?  I have a real estate agent who has given me a few real estate listings in the area that sold in December 2002, along with selling prices. Obviously this should give me some indication, but I want to make sure I follow everything to the letter of the law, so no questions arise from the IRS.

Answer: The IRS website answers the question of "What is Fair Market Value?" with the following information:

Fair Market Value is defined as: "The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent's gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate." Regulation §20.2031-1.

The listings from your real estate agent are a good start, however, if you want to be satisfied that you've carried out due diligence, consider hiring a state licensed or certified appraiser (roughly $200 - $400) who can take a look at the property and give you a bona fide valuation of the property at that point in time.

Check out these IRS publications for more information:

• Publication 551, Basis of Assets
• Publication 559, Survivors, Executors, and Administrators
• Publication 555, Community Property

Question: I want to purchase an investment property on Long Island, NY. Currently I do not own a home but the property is a great deal. The seller is a friend of the family and will sell the single-family home to me for $125,000. The house is worth around $230,000.

If I refinance the mortgage or take out a home equity loan six months from now and take the equity to pay bills and put a down payment on a primary residence will I still be charged capital gains tax for the $105,000 when I sell the house?

Answer: My first question is who told you the house is worth $230,000? I don't know your friend, and maybe they are really nice, but check on that value independently. I don't know of too many people that will let go of $105,000 in equity just like that.

You can approach this transaction a couple of ways. You could move into the property and postpone your investment purchase for a couple of years. (The minimum amount of time you must live in a property to be able to take the $250,000 exclusion -- $500,000 for married filers.)

If the sales price and value you're quoting are accurate – you will have made at least $105,000 in equity in just 24 months. Then you could sell it, take the cash tax free and do what you want with the remaining money.

If you pursue the transaction the way you're describing, buying it then refinancing it soon thereafter, then yes, you will owe capital gains taxes when you eventually sell it. By the way, you don't have to wait six months to gain access to your equity. You can simply record a note on it as soon as settlement is over to cash in.

Published: January 2, 2004

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