Ask Liz Weston

Get smart with your money

Taxes

Inheriting stocks after a parent’s death resets the cost basis

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Dear Liz: I am a beneficiary of my father’s brokerage account. Upon his death, the brokerage company closed his account and transferred all of the equities to me in a new account. How will I know the cost basis for capital gains purposes when I sell the stocks?

Answer: You will use the value of the stocks on the day of your father’s death as the new tax basis. This is known as a “step up” in basis, since typically the fair market value at death is higher than the original basis, or what your dad paid for the stocks. Any appreciation that occurred during his lifetime won’t be taxed, but you would be subject to capital gains tax on any appreciation that occurs after that date.

Does this church pastor need to confess to the IRS?

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Dear Liz: As a recent member of our church board, I just discovered our church hasn’t been paying Social Security or Medicare taxes for our pastor. I checked with our pastor and he hasn’t been making any payments either. This has been going on for six years. How do we recover?

Answer: Clergy are generally exempt from having Social Security and Medicare taxes withheld from their wages, notes Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. However, clergy typically must pay self-employment taxes, which include Social Security and Medicare, unless an exemption has been approved by the IRS.

Normally, employers and employees each pay 7.65% of the employee’s wages to cover Social Security and Medicare taxes. Self-employed people typically must pay both the employer and employee shares, or a total of 15.3%.

If your pastor has been filing taxes as a self-employed person, then he probably has been paying the appropriate Social Security and Medicare taxes. If he hasn’t, however, he may owe a substantial tax bill and should consider hiring a tax pro to help him amend his returns.

Q&A: A husband is deported, leaving his American wife with questions about tax filings

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Dear Liz: I am a 56-year-old married U.S. citizen. My husband of six years was deported to the United Kingdom. Appeals to U.S. Citizenship and Immigration Services were denied. He can never return. I remain in the U.S. and will do so at least until I retire, likely at age 72. What status should I claim for federal and state taxes?

Answer: You have two options for filing taxes when you’re married: jointly and separately. Married filing jointly is often the better choice since it offers a larger standard deduction, higher phase-out limits for certain tax breaks and more favorable tax brackets, especially at higher incomes, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting.

Filing jointly would require including both spouses’ worldwide income, however. Filing separately would allow you to report only your own income.

Q&A: Homeownership can be a joy. It’s also full of complicated financial decisions

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Dear Liz: We replaced our original, fire-vulnerable cedar shake roof with 40-year asphalt shingles 17 years ago. I know that home improvements are added to the basis for capital gains calculation when selling the home. But when we get ready to sell the home in a few years, should the actual cost on the project be used? Or, since it was several years ago, should we calculate what a “present value” of the 2007 dollar amount would be? For that matter, should the purchase price of the home be updated to a present value?

Answer: You don’t have to discount the costs of home improvements, but you also don’t get to boost your tax basis to reflect your home’s appreciation.

To review: Your tax basis is the amount you paid for your home, plus the cost of qualifying capital improvements — projects that added to the value of your home, extended its useful life or adapted it to new uses. The tax basis is subtracted from home sale proceeds to determine the potentially taxable capital gain. If you’ve lived and owned a home for at least two of the five years before the sale, you can exempt $250,000 of home sale profits per owner.

Keeping good records of your improvements has become increasingly important over the years, because that exemption amount hasn’t been updated since it was established in 1997. Back then, the median home sale price was less than $150,000 and most home sellers didn’t have to worry about capital gains taxes. Today, the median sales price nationally is over $400,000 and there are hundreds of cities where the typical home is worth $1 million or more, according to real estate site Zillow. That means more sellers are facing capital gains that could be reduced if they have the paperwork to prove they made qualifying improvements.

You can’t include the cost of maintenance or repairs, such as painting, patching or replacing broken hardware. If the repair is part of a bigger project, though, it may qualify as a capital improvement. Replacing a broken window pane is considered a repair, for example, but replacing the whole window is a capital improvement.

You also can’t include in your cost basis any improvement that was subsequently removed or redone. If you’d replaced your roof previously, for example, you couldn’t include that earlier expense when calculating your basis.

Q&A: Long overdue to dust off that living trust

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Dear Liz: It’s been over 25 years since we paid for a living trust from a lawyer. We have since misplaced the original document. Our house is all paid up and we have one child. In case of our death, can he request a copy of the living trust from the county register?

Answer: Some states do allow living trusts to be registered with local courts, but typically these documents are private and never filed with a government agency.

You’re long overdue for an updated document, in any case. Estate plans should be reviewed every three to five years, after major life changes and whenever estate tax laws change — as they did in 2001, 2010 and 2017.

Q&A: Rob Peter to pay … off the mortgage?

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Dear Liz: Would it make sense to pay off a low-balance, refinanced mortgage at 3% using a portion of my wife’s 401(k)? Would that not be better than paying the mortgage off from my IRA? I am 70 and on Social Security. My wife still works, at least till her birthday in December. She will then be 70 as well and should qualify to maximize her Social Security payout.

Answer: It’s not clear how a withdrawal from one account would be “better” than the other, given your similar ages and the fact that either withdrawal would be taxable as income. The more appropriate question might be why you’re in such a rush to pay off this mortgage.

At this point, you’ve paid most of the interest on this loan and your payments are largely principal, so you won’t save much by paying the loan off early. If there’s a compelling reason to do so, then you may want to postpone the withdrawal until your wife retires and you’ll presumably be in a lower tax bracket. A tax pro can help with that projection.

You should be consulting a tax pro in any case, since required minimum withdrawals from most retirement accounts have to start at age 73 and you may need help managing that tax bill.