Ask Liz Weston

Get smart with your money

Taxes

Selling mom’s house may require an appraisal first

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Dear Liz: My mother recently passed away. The title to her home was held in the family trust. My siblings and I are in the process of clearing out the house in preparation for a sale. Do we need to obtain a “step-up” basis appraisal before the sale to use in determining capital gain on the home? We do not know the original price paid for the home in the late 1960s. Alternatively, could we use an appraisal made in November 2016 as a basis and apply the one-time $250,000 capital gain exclusion?

Answer: You definitely need to establish a property’s value for income tax purposes soon after the owner’s death. If you sell within a year, you could use the fair market value as the home’s new basis, said estate planning attorney Burton Mitchell.

“There is no law about this one-year period,” Mitchell said. “It is just what is often used by both IRS and practitioners.”

You may want more certainty or think the sale may not happen within a year. Estate planning attorney Jennifer Sawday of Long Beach recommends you immediately reach out to a real estate agent to get a broker opinion value letter or hire a certified real estate appraiser to determine the exact value of the home at the date of your mother’s death.

“If you are able to sell the home close to or not much higher than the date of death valuation, the trust will not have any capital gains,” she said. “Plus real estate expenses and other trust administration fees will be computed against the home selling price to minimize any capital gains as well.”

A tax pro can help you figure this all out. The costs of hiring tax and legal help can be charged to the estate.

All the gain in value from the past five decades won’t be taxed. In some parts of the country where home prices are high, such as California, that step-up in basis is far more valuable than the $250,000 home sale exclusion, which you wouldn’t be able to use anyway unless you lived in and owned the home for at least two of the previous five years.

Q&A: Here’s a big tax mistake you can easily avoid

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Dear Liz: I’m self-employed and my wife wasn’t working last year. In December, we returned to California and found a small home to purchase using $107,000 I took out of my IRA. Since we weren’t quite certain of what our income would be, we received our health insurance in Oregon through an Affordable Care Act exchange.

When we filed our taxes we got hit with a $20,000 bill for the insurance, because we earned too much to qualify for subsidies, and a $10,000 bill for the IRA withdrawal. Our goal was to own our home outright, which we do, but now we have a $30,000 tax bill hanging over us.

Can we work with the IRS somehow on this? We didn’t “earn” the $107,000; we invested it in a home. It wasn’t income, so why should we be punished for using our savings to purchase a home?

Answer: If you mean, “Can I talk the IRS out of following the law?” then the answer is pretty clearly no. The IRA withdrawal was income. It doesn’t matter what you did with it.

Consider that you probably got a tax deduction when you contributed to the IRA, which means you didn’t pay income taxes on that money. The gains have been growing tax deferred, which means you didn’t pay tax on those, either.

Uncle Sam gave you those breaks to encourage you to save for retirement, but he wants to get paid eventually. That’s why IRAs and most other retirement accounts are subject to required minimum distributions and don’t get the step-up in tax basis that other investments typically get when the account owner dies.

(If you did not get a tax deduction on your contributions, by the way, then part of your withdrawal should have been tax-free. If you’d contributed to a Roth IRA, your contributions would not have been deductible but withdrawals in retirement would be tax-free.)

The IRS does offer long-term payment plans that may help. People who owe less than $50,000 can get up to six years to pay their balances off. You would file Form 9465 to request a payment plan. The IRS’ site has details.

Here’s a good rule to follow in the future: If you’re considering taking any money from a retirement account, talk to a tax professional first. People often dramatically underestimate the cost of tapping their 401(k)s and IRAs; a tax pro can set you straight.

Q&A: Loans, taxes and home sales

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Dear Liz: You recently answered a question about determining home sale profits for a widow. My question is how you calculate taxes when there’s a loan in the mix. For instance, when I bought my home, I took out a mortgage. Subsequently, I took out a second mortgage to pay for a pool and landscaping. I also refinanced several times, but never took a mortgage with cash out. Please advise me how to calculate my cost basis given these loans. Of course, you can broaden your response to include other loan scenarios and how they play into cost basis.

Answer: This will be a short answer, because they don’t. What you owe the mortgage lender(s) is typically irrelevant for calculating your capital gain.

Q&A: Heirs need a pro to sort our tax issues

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Dear Liz: I know that when a person dies, their beneficiaries typically will inherit a home or other real estate at the current market value with no taxes owed on the appreciation that happened during the person’s lifetime. Does that hold true for stocks as well?

Answer: Usually, yes, but there are some exceptions.

If the stock is held inside a retirement account such as a 401(k) or IRA, and that retirement account is bequeathed to heirs, withdrawals will be subject to income tax. The same is true for investments held within variable annuities.

Inheritors also may owe capital gains taxes on a stock’s appreciation if the stock is held in certain trusts, such as a generation-skipping trust.

And even when no taxes are owed on the gain that happened during someone’s lifetime, there may be taxes due on the gain that happens after someone inherits the stock or other property, said Los Angeles estate planning attorney Burton Mitchell.

If you’re expecting an inheritance, you’d be smart to consult a tax pro so you understand the tax bill that may be attached.

Q&A: Independent contractors face a wealth of tax consequences

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Dear Liz: My son was recently hired in his dream job, but his employer has classified him as an independent contractor rather than as an employee. This would be his first time drawing pay without all the taxes, benefits, insurance and so on taken out. I’m afraid he’s only seeing the good wage and not the flip side.

He’s a newlywed and doesn’t need his mama telling him what’s what. I thought if I sent him this “anonymous” letter that appeared in your column, that advice would be coming from you and he might just listen!

Answer: If your son doesn’t listen, that dream job could turn into a tax nightmare.

Tax pros often suggest their self-employed clients put aside half of what they earn to cover taxes and other obligations. Independent contractors have to pay both the employer and employee portion of Social Security and Medicare taxes, or roughly 15.3% instead of the 7.65% regular workers pay. That’s in addition to whatever federal, state and local income taxes he’ll owe.

He’s now required to make quarterly estimated tax payments because ours is a “pay as you go” system. Employees typically have those taxes withheld, but independent contractors must make quarterly estimated tax payments by Jan. 15, April 15, June 15 and Sept. 15. (The deadlines are moved to the following Monday if those dates fall on a weekend.) If he waits until he files his annual tax return to pay, he’ll probably owe penalties.

He also may need to register his business with his city or county and get a tax registration certificate.

If he doesn’t get health insurance through his spouse, he’ll need to find a policy, probably through an Affordable Care Act exchange. He also should save at least something for retirement. Although the self-employed have several good options for retirement savings, including SEP IRAs and solo 401(k)s, he’ll have to do without the “free money” that company 401(k) matches represent.

Business insurance may be another concern. He may need coverage to protect against lawsuits, disabilities and other potential setbacks.

Your son would be smart to hire a tax pro, such as an enrolled agent or CPA, to help him navigate this brave new-to-him world of self-employment.

Q&A: Rebalancing your portfolio can trigger tax bills

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Dear Liz: Is there a tax aspect to rebalancing your portfolio? You’ve mentioned the importance of rebalancing regularly to reduce risk.

Answer: Rebalancing is basically the process of adjusting your portfolio back to a target asset allocation, or mix of stocks, bonds and cash. When stocks have been climbing, you can wind up with too high an exposure to the stock market, which means any downturn can hurt you disproportionately.

There definitely can be tax consequences to rebalancing, depending on whether the money is invested in retirement plans.

Rebalancing inside an IRA, 401(k) or other tax-deferred account won’t trigger a tax bill. Rebalancing in a regular account could. Investments held longer than a year may qualify for lower capital gains tax rates, but those held less than a year are typically taxed at regular income tax rates when they’re sold.

Tax experts often recommend selling some losers to offset winners’ gains, and “robo advisor” services that invest according to computer algorithms may offer automated “tax loss harvesting” to reduce tax bills.