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My father-in-law is nearing death, and no longer in his home. He bought it for perhaps $25k 40 years ago, and it is now worth roughly $275,000. He has lived in it the whole time except the last six months with us. We live in PA where there is a 4.5% inheritance tax for children. (His wife died years ago.) His total estate including house is a little over $1 million.

So, should we sell the house before he dies? - There would be no capital gains tax to pay since he has lived there?

Or after he dies? Is there an automatic bump up in the capital basis so no tax again on the capital gains?

Which is it?

Fred
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There would be no capital gains tax to pay since he has lived there?

uh-oh, no. If you sell the home before he dies, he will pay a capital gains tax on the $250k gain he makes.

If you wait till his death, there'll be a stepped up basis, so his estate won't owe capital gains tax.

In either case, you'll owe 4.5% inheritance tax on whatever assets you inherit.

Estate tax is paid by the estate before the assets are distributed. Inheritance tax is paid by the beneficiaries on the assets they receive. I'm not sure this bit of information will make any difference in your case.

Trini
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uh-oh, no. If you sell the home before he dies, he will pay a capital gains tax on the $250k gain he makes.

What about the $250K capital gains exclusion on the sale of a personal residence?

Bob
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Whoops - that exclusion would cover the gain, wouldn't it. My mistake. Sorry.

Trini
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So it seems better to sell the house before he dies, because of the personal residence exclusion.

But after he dies, is there a bump up in the basis, so that if we sell
the house immediately afterwards, there would be no capital gains?

Fred
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Or after he dies? Is there an automatic bump up in the capital basis so no tax again on the capital gains? - Fred

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No step up in 2010.... You can google "basis step up 2010" and get lots of hits.... Heres just one.

Best wishes, bhm

http://ezinearticles.com/?No-Stepped-Up-Basis-For-Estate-Inh...

Up until 2010, property owned by a decedent at the time of death of his death had its tax basis changed from what the decedent's basis was to its fair market value - whichever was higher. For the year 2010 - and only that year - the law has been changed to 'whatever is lower'. This change will generally cost inheritors of decedents who die in 2010 more taxes down the line - especially for those inheriting houses.

.... more at link
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OK, it seems that there is a 1.3 million allowed bump up.

"But in 2010, heirs must assume, or carry over, the departed's basis in the property. This, of course, has tax ramifications. Since some property will have greatly appreciated over the years, lawmakers decided to give heirs a bit of basis consideration: $1.3 million of inherited property receives a step-up in basis, with surviving spouses getting an additional $3 million, bringing the basis total for a widow or widower to $4.3 million."

Or for a clearer example:
http://www.bankrate.com/finance/taxes/estate-tax-elimination...

"Fast forward to 2010. The widow dies that year and leaves the same $2 million home to her only child. Since the estate tax is repealed, there is no worry in that area. However, if the child decides to sell the inherited home, the basis issue looms large. Rather than being able to use the $2 million market value as basis, the heir can only claim a basis of $1.3 million. That means a sale price of $2 million will leave the child with $700,000 in profit on which taxes are due, or a tax bill of $105,000."

So in this case the step up basis is way less than 1.3 million, so it should not make a difference either way.
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