Ask Liz Weston

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Home Sale Tax

Q&A: When an inherited house gets sold, it pays to know the tax rules

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Dear Liz: My sister and I inherited a house from our mom in 2003. Back then, it was appraised at close to $500,000. It’s now worth $1.3 million and we want to sell and split the profits. My sister has lived in the house since Mom passed. Approximately what would the tax liability be?

Answer: You’ll determine the potentially taxable profit by subtracting the tax basis — the amount the house was appraised for at your mother’s death, plus any qualifying improvements — from the sale proceeds. Your sister can exempt $250,000 of her share of the profits, since she has owned and lived in the house for two of the previous five years. If her share of the profit was $400,000, for example, she would owe long-term capital gains taxes on $150,000 of that.

As a non-occupant, you wouldn’t have the option to exempt any of the profit, so you would owe long-term capital gains taxes on your entire $400,000 share. Long-term capital gains rates depend on your income, but the federal rate is 15% for most.

Q&A: How do I find an estate planning attorney I can afford?

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Dear Liz: The question from the couple who wanted to leave a home to their four children hit home with me. I’m in the same boat but with only two kids. How do I go about finding an estate planning attorney that I can trust and also afford?

Answer: Start by asking for recommendations from friends, family and any financial professionals you trust. If you already have a CPA, for example, chances are they can refer you to a good estate planning attorney in your area. Consider interviewing a few candidates to make sure they handle situations similar to yours.

If you’re trying to keep costs down, consider the attorney’s overhead. Fancy buildings in expensive areas may impress, but you can find competent attorneys in less ornate offices, perhaps in suburbs or smaller towns, who charge less.

Q&A: What to know about capital gains tax on a house sale

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Dear Liz: My husband died in November 2022. I was told that if I sell the house within two years of his death, I can benefit from two capital gains exclusions, his and mine, each for $250,000. The house was appraised at $912,000 based on his date of death. I don’t imagine it would sell for much more than that now. Can you tell me approximately what I would owe in capital gains? My tax rate is 24%.

Answer: That’s a great question to ask a tax pro, since there are a number of variables involved.

If you live in a community property state such as California, then both halves of the property got a favorable step-up in tax basis when your husband died. That means the house’s new tax basis would be $912,000.

If you don’t live in a community property state, then only half of the house got the step up at his death (to $456,000, or half of $912,000). The other half — yours — retains its original tax basis. If the original purchase price of the home was $300,000, for example, your basis would be $150,000. The home’s total basis would be $606,000 (which is $456,000 plus $150,000). If you sold the house for $912,000, your capital gain could be $306,000, which would be well below the $500,000 exemption you could take if you sell the house within two years of the death. If you sell after the two-year mark, the gain above your single $250,000 exemption would be taxable.

The rate you would pay depends on your taxable income and what state you live in.

For example, a single person with taxable income of between $47,026 and $518,900 in 2023 would pay a 15% federal capital gains rate, plus whatever rate their state imposes. (California doesn’t have a separate capital gains tax system, so any taxable gain would be subject to the state’s regular income tax.)

These numbers are just to give you an idea of how capital gains taxes work. Your mileage may vary. If you renovated the kitchen or did any other significant improvements on the home, those costs could be added to your tax basis to reduce any potentially taxable gain. Also, selling costs will reduce what you actually pocket from the sale and your potentially taxable gain. For more information, see IRS Publication 523, Selling Your Home.

Taxes shouldn’t be your only consideration, of course. Relocating can be disruptive and expensive. Getting the house sold before the two-year mark makes sense if you were planning to move anyway, but don’t let fear of taxes scare you out of a home that otherwise suits you.

Q&A: Home sales and taxes

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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: When selling a vacation home, here are the taxes to expect

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Dear Liz: I am one-third owner of a vacation house. My siblings own the other two-thirds. We inherited the house from a parent about 10 years ago. I want to sell my third to my siblings, who are willing and able to buy it. Can I do anything to avoid capital gains? Would it make a difference if I sell my interest over several years?

Answer: Vacation homes aren’t eligible for the tax break that allows people to exclude up to $250,000 in capital gains from their income when they sell their primary home. If the property was used full time as a vacation or second home, rather than as a rental, it’s also not eligible to be swapped for another property in a 1031 exchange. (These exchanges allow investors to defer capital gains on real estate investment properties.)

Selling your share of the property over time won’t eliminate the capital gain, but it would spread out the tax bill. Discuss your options with a tax pro to see which approach makes the most sense.

Q&A: Capital gains taxes on a house sale

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Dear Liz: We purchased our home for $220,000 in 1986 and are selling it for $1 million. We own it free and clear. The proceeds from the sale will be going toward the purchase of another property, to be owner-occupied, for $1.4 million. We will be coming in with additional cash to cover the difference. Our question is whether we will be subject to capital gains tax on the proceeds from the sale of our current home.

Answer: Most likely the answer is yes.

Each owner can exclude up to $250,000 of gain from the sale of their primary residence as long as they owned and lived in the home at least two of the previous five years. Whether they have a mortgage and what they do with the money afterward isn’t relevant for calculating this tax.

You may be able to reduce the capital gains tax bill if you paid for home improvements over the years and kept good records. According to the IRS, improvements or additions that “add to the value of your home, prolong its useful life, or adapt it to new uses” can be added to your tax basis, which is usually the amount you spent to buy the home. IRS Publication 523, Selling Your Home, has details.