Housing Counsel: Don't Forget the Stepped up Basis

Written by Posted On Sunday, 19 March 2006 16:00

Question: My husband and I purchased our home back in 1975 for approximately $20,000. He died in 1983, and I have lived in the house since we first bought it. I would like to move to another residence. I believe I can sell the house for $400,000, and am looking at another property in the range of $325,000. Will I have to pay any capital gains tax?

Answer: Let us first assume that you and your husband are alive and have lived in the property all these years. Under the current tax law, if you have owned and occupied a house as your primary residence for two year out of five years before it is sold, if you file a joint income tax return, you can exclude up to $500,000 of any gain. If you are not married, or do not file a joint return, you can only exclude up to $250,000 of the profit you have made.

How do you determine profit? According to the IRS, there is a simple formula:

Selling Price - Selling Expenses = Amount Realized

Amount Realized - Adjusted Basis = Gain or Loss

You paid $20,000 for the house. That's that the tax people call "basis." You can also add to this basis certain closing costs which you paid when you first went to settlement. That's why it is critical to keep copies of all settlement statements (HUD-1s) for your properties.

Some of the closing costs which can be added to basis include:

  • legal fees

  • recording fees

  • survey cost

  • transfer tax

  • owner's title insurance premium

If you made major improvements to your property over the years, and these improvements have a useful life of more than one year, these costs can also be added to basis.

Let's further assume that you did not make any improvements and for this example we will ignore closing costs and other expenses which ordinarily can be included in the computation of gain.

You paid $20,000, and will be selling the property for $400,000. That is a gain (profit) in the amount of $380,000. If you were still married, you would be able to exclude this entire gain and use all of the sales proceeds to purchase your new house. You do not have to trade up; you do not even have to buy another house. This money is yours to do with as you see fit.

However, in your case, your husband died in 1983. You have to determine the value of the house on the date of his death. You may be able to find this in any documents which may have been filed with the Probate court. Otherwise, you will have to look at newspapers, tax office records or just make an educated guess.

Let's assume the property was worth $100,000 when your husband died. Under the law, you are able to take what is known as the "stepped up" basis in the property. You paid $20,000 for the house, so your basis was half of this, namely $10,000. When your husband died, your basis was increased by half of the value on the date of death -- namely $50,000. So, your basis for income tax purposes is now $60,000 ($10,000 + $50,000).

You sell the property for $400,000. Your gain is $340,000. Since you no longer file a joint tax return, you can exclude up to $250,000 of this gain, but the difference ($90,000) is taxable. Currently, the capital gains tax rate is 15 percent, so you will have to pay Uncle Same $13,500, plus whatever tax your local jurisdiction will assess against you.

As you can see, the more legitimate expenses you can include when you compute your basis, the less tax you will have to pay.

For example, when you sell your house, you may be paying a real estate commission. This entire amount can be used to adjust your gain downward. Similarly, any recordation tax which you have to pay to sell your property is also a legitimate item to adjust your basis.

This is really not complicated, but you have to make sure that every legitimate expense which you paid when you owned the house is accounted for. The IRS has a simple English publication which will be helpful. (Publication 523: Selling your Home for use in preparing 2005 Returns). This is available on the web at irs.gov . (click on Forms and Publications)

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Benny L Kass

Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of KASS LEGAL GROUP, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.


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