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home sale exclusion

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: Complicated condo question

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Dear Liz: You recently answered a question about gifting a condo. I understood the first part of your answer: If the person receiving the gift lives in the condo for two of the last five years, then there is no capital gains exposure. The second part of your answer is a little confusing to me. You wrote, “However, her taxable gain would be based on your tax basis in the property: basically what you paid for the home, plus any qualifying improvements.” So, if my mother gifted her condo to me and she paid $50,000 for it 40 years ago, and the condo today is selling for $250,000, what is my capital gains exposure? To keep it simple, assume no capital improvements or other factors.

Answer: Living in and owning a home for two of the previous five years does not erase someone’s capital gains exposure. Instead, they’re entitled to exclude up to $250,000 of home sale gains from their income.

In the case you describe, your potentially taxable capital gain would be $200,000. That’s the selling price of $250,000 minus your mother’s tax basis (which is now your tax basis) of $50,000.

If you owned and lived in the home at least two of the previous five years, your exclusion would more than offset your gain, so the home sale wouldn’t be taxable. If you didn’t make it to the two-year mark, you could get a partial exemption under certain circumstances, such as a work- or health-related move. For more details, see IRS Publication 523, “Selling Your Home.”