Q&A: Death means capital gains take a holiday for heirs selling a house

Dear Liz: I am in my mid-80s and in declining health. I want to advise my beneficiaries about possible taxation on the sale of my home after I expire. I bought the place in 1995 for $152,000. It now has a market value of about $400,000. The issue is whether that gain is taxable upon the sale after my death. I also have a $57,000 long-term capital loss carry-forward in my income taxes, which is being written off at a rate of $3,000 each year.

Answer: The gain in your home’s value won’t be taxable at your death. Instead, the home will get what’s known as a “step up in basis.” That means its new value for tax purposes will be its market value when you die. So if it’s worth $400,000 when you die and your heirs sell it for $400,000, no capital gains taxes will be owed on the sale.

The news isn’t so good for your capital loss, however. Any unused carryover expires at your death and can’t be transferred to your estate.

As you know, capital losses — losses on investments or assets that you sell — can be used to offset capital gains and reduce your tax bill. If your losses exceed your gains, you can offset up to $3,000 of ordinary income each year. Any capital loss remaining after that can be used the next year in the same way: first to offset capital gains, then to offset up to $3,000 of ordinary income.

Often when taxpayers have such a loss, they’re encouraged to sell investments that have increased in value to help use up the loss faster, but you should talk to your tax pro and estate planning attorney to see if that makes sense in your case.

Q&A: Figuring the tax toll for an inherited house

Dear Liz: I inherited my home when my husband died. If I sell this house now at a current market value of around $900,000, what will be the basis of the capital gains tax? I think at the time of my husband’s death, the house’s market value was $400,000.

Answer: Based on your phrasing, we’ll assume your husband was the home’s sole owner when he died. In that case, the home got a new value for tax purposes of $400,000. That tax basis would be increased by the cost of any improvements you made while you owned it. When you sell, you subtract your basis from the sale price, minus the costs to sell the home, such as the real estate agent’s commission, to determine your gain. You can exempt up to $250,000 of the gain from taxation if it’s your primary residence and you’ve lived in the house at least two of the previous five years. You would owe capital gains taxes on the remaining profit.

Here’s how the math might work. Let’s say you made $50,000 in improvements to the home, raising your tax basis to $450,000. You pay your real estate agent a 6% commission on the $900,000 sale, or $54,000. The net sale price is then $846,000, from which you subtract $450,000 to get a gain of $396,000. If you meet the requirements for the home sale exclusion, you can subtract $250,000 from that amount, leaving $146,000 as the taxable gain.

If your husband was not the sole owner — if you owned the home together when he died — the tax treatment essentially would be the same if you lived in a community property state such as California. In other states, only his share of the home would receive the step-up in tax basis and you would retain the original tax basis for your share.

Q&A: The future is bleak for charitable deductions, early retirees’ healthcare costs

Dear Liz: When I sat down with my accountant in March to do my 2017 taxes, he said next year I will take the standard deduction. Are my contributions to charity still deductible if I take the standard deduction?

Answer: No. Charitable contributions are an itemized deduction. If you don’t itemize your deductions, you won’t get the tax break.

Congress nearly doubled the standard deduction as part of its tax reform. For married couples, the standard deduction is now $24,000, up from $12,700. The state and local tax deduction was capped at $10,000. As a result, the proportion of taxpayers who will itemize their deductions is expected to drop from about 30% to 10% or less.

Beware of hidden taxes in retirement

Your taxes in retirement may be a lot more complicated than taxes while you’re working.

Social Security checks may or may not be taxed, depending on your income. You’ll pay federal income taxes on most retirement plan withdrawals, but additional state taxes depend on where you live. Tax rates on investments can vary as well.

In my latest for the Associated Press, what to expect when you hit retirement age.

Q&A: Giving stock to your children

Dear Liz: We plan to give our children some stock that we have had for several years. What is the tax consequence when they sell it? Is it the difference from the value when we gave it to them till they sell it, or the difference from the value when we purchased it?

Answer: If the stock is worth more the day you give it to them than it was worth when you bought it, you’ll be giving them your tax basis too.

Let’s imagine you bought the stock for $10 per share.

Say it’s worth $18 per share when you gift it. If they sell for $25, their capital gain would be $15 ($25 sale price minus your $10 basis). They will qualify for long-term capital gains rates since you’ve held the stock for more than a year.

If on the day you give the stock, it’s worth less than what you paid for it, then different rules apply. Let’s say the stock’s value has fallen to $5 per share when you gift it.

If your children later sell for more than your original basis of $10, then $10 is their basis. So if they sell for $12, their capital gain is $2.

If they sell it for less than $5 (the market value when you gave it), that $5 valuation becomes their basis. If they sell for $4, then, their capital loss would be $1 per share ($4 sale price minus $5 basis). The silver lining: Capital losses can be used to offset income and reduce taxes.

Finally, if they sell for an amount between the value at the date of the gift and your basis — so between $5 and $10 in our example — there will be no gain or loss to report.

If, however, you wait and bequeath the stock to them at your death, the shares would get a new tax basis at that point. If the stock is worth more than what you paid, your kids get that new, higher basis. So if it’s worth $25 on the day you die and they sell for $25, no capital gains taxes are owed. If it’s worth $5 when you die, though, the capital loss essentially evaporates. Your kids can’t use it to offset other income.

Q&A: If your job reimburses you for education costs, can you still get a tax deduction?

Dear Liz: I established a Coverdell Education Savings Account for my son about 20 years ago. My son has since graduated, and there is still about $12,000 left in that account. He has worked a few years and now is going to graduate school while still being employed. His employer will do education reimbursement.

How should we withdraw the funds to qualify for the education expense deduction come tax time?

Answer: Congress recently eliminated the tuition and fees deduction, but the American Opportunity Tax Credit and the Lifetime Learning Credit remain for 2018. For you to claim an education credit, however, your son would have to be your dependent. If your son is working full time, he’s probably not a dependent. He may be able to take a credit, but only for qualified education expenses that aren’t reimbursed by his employer or paid by a Coverdell distribution. Taxpayers aren’t allowed to double-dip — or potentially, in this case, triple-dip — on education tax benefits.

If your son incurs education expenses in excess of what his employer reimburses, then funds in the Coverdell ESA could be used to pay for those costs or reimburse your son for the additional out-of-pocket education expenses he paid in the same year as the distribution, said Mark Luscombe, principal tax analyst at Wolters Kluwer Tax & Accounting. Once the Coverdell is depleted, your son may be able to take a credit for any remaining qualified education expenses.

Q&A: Selling a home you’ve shared with tenants

Dear Liz: I am 53 and own a home in which I live and rent out rooms. Every year I pay my taxes on the rental income and get to deduct depreciation.

How does this affect the taxes I will pay on the home when I sell it? Will I be able to claim the $250,000 exemption? I may live in this home until my death and leave it to my children. How would the rental depreciation affect their stepped-up basis and any taxes they might have to pay?

Answer: Renting rooms is similar to taking the home office deduction in the Internal Revenue Service’s eyes. In both cases, you have to recapture any depreciation, but the business use doesn’t affect your ability to take the home sale exclusion.

The home sale exclusion allows you to exempt from capital gains taxes up to $250,000 of home sale profit. (The exclusion is per owner, so a married couple potentially could exempt up to $500,000.) You’re eligible for the exclusion if you have owned and used your home as your primary residence for at least two years out of the five years before the sale. You will have to pay income taxes on the amount of depreciation you deducted over the years. That depreciation amount is added back as income on your tax return.

If the space you rented out had not been within your living area — if it were a separate apartment or retail space — then different rules would apply.

If you decide to bequeath the home at your death rather than selling it, your heirs won’t have to pay the depreciation recapture tax — or capital gains taxes on any appreciation that took place while you owned it. Instead, the home’s tax basis will be “stepped up” to its current market value.

If they sell it soon after inheriting it, they won’t owe much if any tax on the sale. If they hang on to it before selling, they’ll owe taxes only on the appreciation that took place while they owned it. If they move in and make it their primary residence, they too could qualify for the $250,000-per-person home sale exclusion once they have owned the home, and used it as their primary residence, for at least two of the five years before they sell it.

Thursday’s need-to-know money news

Today’s top story: Start prepping for next year’s taxes now. Also in the news: Taking the shame out of rebuilding your finances, 3 reasons to hire a fee-only financial planner, and what you should know about Roth IRA withdrawals.

Do Future-You a Solid: Prep for Next Year’s Taxes Now
Give 2019 You a head start.

To Rebuild Your Finances, Take Shame Out of the Equation
Don’t let your emotions hold you back.

3 Reasons to Hire a Fee-Only Financial Planner
Their focus is on advice.

What You Should Know About Roth IRA Withdrawals
The rules are complicated.

Wednesday’s need-to-know money news

Today’s top story: 5 great ways to invest your tax refund. Also in the news: How to say no to being a bridesmaid, when to upgrade at the gas pump, and how to decode your financial aid letters.

5 Great Ways to Invest Your Tax Refund
The best ways to put your windfall to good use.

Ask Brianna: How to Say No to Being a Bridesmaid
While keeping your friendship intact.

Premium and ‘Top Tier’ Gas: When to Upgrade at the Pump
When the higher octane is necessary.

How to Decode Your Financial Aid Letters
Deciphering your offers.

Tuesday’s need-to-know money news

Today’s top story: What really happens if you don’t pay your taxes by April 17th. Also in the news: Getting tax audit help might be easier than you think, are you the right person for a do-it-yourself house kit, and 6 great TV episodes to watch after paying your taxes.

What Really Happens If You Don’t Pay Your Taxes by April 17
Cue the penalties.

Getting Tax Audit Help Might Be Easier Than You Think
Your tax software can help.

Are You Built for a Do-It-Yourself House Kit?
Do you have what it takes?

6 Great TV Episodes to Watch After Paying Your Taxes
Join The Honeymooners, Archie Bunker and Homer.