Q&A: Determining a house’s value

Dear Liz: I understand that as a widow, if I sell my house I get the stepped-up value from the year my husband died. Should I have gotten an appraisal at that time (26 years ago)? How do I find out what my home was worth then? We bought it in 1973 and he died in 1998.

Answer: In most states, half of a couple’s jointly owned property gets a new, favorable step-up in tax basis at a spouse’s death. In community property states such as California, both halves of the property may get that step-up.

A professional appraisal 26 years ago could have been helpful, although a good appraiser can do a retroactive assessment, said Jennifer Sawday, an estate planning attorney in Long Beach.

Before you hire an appraiser, though, hire a tax pro, Sawday said. The CPA or tax preparer will use the data to file your return, report your home sale and compute any capital gains taxes owed, so find out how they recommend obtaining it.

Q&A: Their variable-rate loan is out of control. What should they do now?

Dear Liz: We paid a lot for our house, and a lot to renovate it seven years ago. My banker recommended taking a low-interest loan against our assets at the bank instead of selling investments to pay for the renovations, which cost $900,000. The bank offered a rate of prime plus half a point. Up until a year ago, this loan cost me about $1,200 to $1,600 per month. However, those payments have now jumped to about $5,000 per month. I’m selling stocks and bonds, on which I will have to pay taxes, to cover this amount. We have enough to pay off the loan, which is what my banker has suggested doing since interest rates have gone up so much. However, my wife and I are reluctant to liquidate so much in stocks and bonds. We would incur the tax consequences and it would not leave us as liquid as we would like to be. We love our house and neighborhood, and we are locked in a mortgage rate of 2.65% for another six years, so we are reluctant to sell. Any advice?

Answer: Your options aren’t great, but you already knew that.

As you’ve learned, variable-rate loans are inherently risky and better for short-term borrowing than for financing long-term debt. Interest rates stayed so low for so long that many people lost sight of the risk that affordable payments might not stay that way.

Interest rates are unlikely to plunge any time soon, but paying off the loan by selling investments could leave you house rich and cash poor. If interest rates do ease, you could regret having incurred unnecessary taxes — plus the investments you sell can’t earn you future returns.

Trying for a cash-out mortgage is another potential solution with significant disadvantages, given current high mortgage rates. Selling your home could be the best option if you can’t afford the property but may be an overreaction if you can.

The right solution will depend on the details of your financial situation. A fiduciary financial advisor — someone dedicated to putting your best interests first — could help you make a more informed decision about what to do next.

Q&A: Home sales and taxes

Dear Liz: My in-laws passed away earlier this year within months of each other. Their primary asset, part of their living trust, is their home, worth close to $1 million. There is a reverse mortgage of about $332,000 that will be paid off once the house sells. Will capital gains tax apply to the four beneficiaries? Or do we get to take advantage of the step up in cost basis? The house is in escrow right now. I don’t think the house has gone up in value since the last death.

Answer: The home will get the favorable step up in tax basis. That means the beneficiaries won’t have to pay capital gains tax on all the appreciation that happened during the parents’ lifetime.

Q&A: What to know about buying a house using retirement funds

Dear Liz: My husband and I are thinking of purchasing a house near us. Can we use any funds from our retirement accounts to make the purchase? We would like to use this money along with some savings so that we do not have to carry a mortgage.

Answer: You don’t mention how old you are, whether you’re currently homeowners or what type of retirement accounts you have, which are all important factors.

If you’re under 59½, withdrawals from IRAs and workplace plans such as 401(k)s are typically taxed and penalized. You can avoid the penalty, but not the taxes, if you’re considered a “first-time home buyer” and you withdraw up to $10,000 from your IRA to buy a home. (“First-time home buyer” just means you and your spouse haven’t owned a home within the last two years.)

This exception doesn’t apply to workplace plans such as 401(k)s. However, if you’re still working for the employer who provides the plan, you could consider taking a loan from your account.

Loans typically must be repaid within five years, but your employer may offer a longer payback period for the purchase of a primary residence. If the employer permits plan loans, the loan limit is typically the lesser of $50,000 or half the vested account balance, said Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

An exception to the 50% cap is if 50% of your vested account balance is less than $10,000, Luscombe said. In that case, you can borrow up to the lesser of $10,000 or the balance in your account.

If you have a Roth IRA or Roth 401(k), the amount you contributed can be withdrawn for any purpose without taxes or penalties, Luscombe said.

Q&A: Surviving spouse’s home gains

Dear Liz: If a surviving spouse is selling the couple’s longtime home, are there any special provisions on the long-term capital gains?

Answer: When one spouse dies, their half of the home gets a new value for tax purposes. The value is “stepped up” to the current market value, so that the appreciation that happened on that half of the property is no longer taxable. In community property states, both halves of the property get this step up.

Let’s say a couple bought a home for $100,000 and that it was worth $250,000 when the first spouse died. In most states, the tax basis — what’s subtracted from the net sales price to determine potentially taxable capital gains — would rise from the original $100,000 to $175,000. The surviving spouse’s basis would remain at $50,000 while the deceased’s half would be stepped up to $125,000 (one half of the current $250,000 value). If the home was sold for $250,000, there would be $75,000 of potentially taxable capital gain.

In community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin — the home’s basis would get a double step-up to $250,000. If the home was sold for $250,000, there would be no potentially taxable capital gain.

Even if there is a gain from the sale, a single person can exclude up to $250,000 of home sale capital gains from their income as long as they owned and lived in the home at least two of the previous five years. Couples can exclude up to $500,000. However, widows and widowers who sell their homes within two years of their spouse’s death can take the full $500,000 exclusion.

Q&A: Transfer-on-death deed

Dear Liz: Having been through the probate process several times in California and Nevada, I can say it stinks. It’s expensive and occurs at a time when family is most stressed and saddened after having lost a loved one. Although estate planning and revocable trusts seem to be all the rage, I’d like to recommend another path: transfer-on-death deeds for real estate. They are available online via the county. It avoids a complicated probate, is far simpler than a living trust and still gives the family the benefit of a stepped-up tax basis on the property.

Answer: Probate isn’t always a nightmare. Some states have adopted reforms that make the process less expensive and protracted. Even in states with notoriously slow and expensive probate, such as California, there are typically rules that allow small estates to bypass most of the red tape.

Because of the rising value of real estate, however, simply owning a home can be enough to trigger probate even when the deceased has few or no other assets. Thus, many states now offer the option of transfer-on-death deeds for real estate, and they can be a good solution for people who don’t own much other than a home.

Q&A: How a ‘like-kind’ 1031 exchange can help you defer real estate capital gains taxes

Dear Liz: My husband and I are selling a commercial property for $600,000 and we have capital gains questions. Our Realtor said that we have 90 days to buy another property but suggested we don’t make a purchase due to the state of the economy at this time. We are looking for any suggestions to lessen our capital gains. Do you have any suggestions that we could look into or articles to read?

Answer: Your Realtor is referring to what’s known as a “like-kind” or Section 1031 exchange. These exchanges allow people to defer capital gains taxes when they sell commercial, rental or investment real estate as long as the proceeds are used to purchase similar property.

Section 1031 exchanges happen all the time, in all sorts of economic conditions, so your Realtor’s attempt to dissuade you based on “the state of the economy” is a bit odd. Also, like-kind exchanges don’t have to be completed in 90 days. Owners have 45 days to identify potential replacement properties and a total of 180 days to complete the transaction. There are a number of other rules you must follow, so you’ll want to use companies known as exchange facilitators that specialize in handling these transactions.

Your first step, though, should be finding a qualified tax professional. You’ve just experienced what can happen when you turn to non-tax professionals for tax advice.

While your desire to educate yourself is laudable, and you certainly can find books about taxes at your local bookstore, there’s no substitute for consulting an experienced tax pro who can give you personalized advice.

Q&A: Newlyweds’ home sale taxes

Dear Liz: You recently wrote about how home sales are taxed but I have a question. My son was single when he bought his condo. He is now married and planning on selling it. Does he qualify for the $250,000 exclusion or the $500,000 exclusion?

Answer: As you know, the exclusion allows home sellers to avoid capital gains taxes on a certain amount of profits as long as they owned and lived in the home at least two of the previous five years. With married couples, only one spouse needs to meet the ownership test but both must meet the “use” test. In other words, both your son and your son’s spouse must have lived in the home for at least two years before the sale for the couple to qualify for the $500,000 exclusion. The couple must file a joint return in the year they sell the condo, and neither spouse can have excluded gain from the sale of another home during the two-year period before selling this home.

Q&A: Capital gains tax

Dear Liz: I am selling my house. After subtracting all selling costs, stepping up the basis for capital improvements over the years, and using the $500,000 capital gains exclusion from the IRS, I will still have a significant capital gains tax due. Does this tax need to be paid via the quarterly estimated tax in the quarter the house closes, or can I wait and pay the capital gains tax with the yearly tax filing?

Answer: If you are the sole owner of the home, then you can exclude up to $250,000 of capital gains from a home sale. If you’re married then the exclusion amount is doubled to $500,000.

Ours is a “pay as you go” tax system, which means you’re supposed to withhold the appropriate taxes as you earn or receive income. If you don’t withhold enough, you can owe penalties. People who don’t have regular paychecks or who experience windfalls, such as your home sale, may have to make quarterly estimated payments to ensure they’ve paid enough to avoid the penalties.

One way to avoid penalties is to make sure your 2022 withholding at least equals your 2021 tax bill, if your adjusted gross income is $150,000 or less. If your adjusted gross income is more than $150,000, your withholding needs to equal 110% of your 2021 tax bill. Another is to pay 90% of your 2022 tax bill. It’s tough to know what your tax bill is going to be before the year ends, though, so most people choose to withhold based on their 2021 tax bill. If your 2022 bill will significantly exceed your withholding, however, you’ll want to make sure you stash the appropriate cash in a safe, FDIC-insured savings account so it’s available when you have to pay Uncle Sam next year.

Q&A: How previous home sales might affect your capital gains taxes

Dear Liz: I am selling my house and will not be buying another one. I believe that I know the rules of capital gains taxes in general. However, must I include the capital gains of previous homes, even those experienced many years ago?

Answer: Possibly.

Before 1997, homeowners could avoid capital gains taxes by rolling their profits into another home, as long as the purchase price of the new house was equal to or greater than the home they sold. Homeowners 55 and older could get a one-time exclusion of up to $125,000.

The rules changed in 1997. Now homeowners can exclude up to $250,000 of home sale gains as long as they have owned and lived in the home at least two of the prior five years. A married couple can exclude up to $500,000.

If you have not sold a home since the rules changed, however, any previously deferred gains would lower the tax basis on your current home.

Let’s say you bought your current home for $300,000 prior to 1997. Normally, that amount (plus certain other expenses, including qualifying home improvements) would be your tax basis. If the net proceeds from your sale were $500,000, for example, you would subtract the $300,000 basis from that amount for a capital gain of $200,000.

But now let’s say you rolled $200,000 of capital gains from previous home sales into your current home. That amount would be subtracted from your tax basis, so your capital gain would be $400,000 — the $500,000 net sale proceeds minus your $100,000 tax basis.

Before selling any home, you should consult with a tax pro to make sure you understand how capital gains taxes may affect the sale. You don’t want to find out you owe a big tax bill after you’ve spent or invested the proceeds.