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I am trying to confirm my understanding of any potential Federal income tax liability on the sale of my Mom's house, which I inherited in 2012, and will hopefully be selling in 2014. The home was her personal residence and was never an income producing property. I had an appraisal done in 2012 within a couple months of her passing in October 2012.

My question: Is there any Federal income tax liability on the appreciated value of the home (net sales price less the appraisal amount plus the cost of getting the property ready for sale ~ painting, new carpeting etc.)?

I want to make it clear that I am not speaking of Inheritance or Estate taxes (Federal or State) because I have determined that this sale is well below the $$$ threshold required for these type of taxes.

TIA

Rich
Arizona
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My question: Is there any Federal income tax liability on the appreciated value of the home (net sales price less the appraisal amount plus the cost of getting the property ready for sale ~ painting, new carpeting etc.)?

Yes, there is. And you've described the calculation fairly well. For the house you inherited from your mother, it is as if you bought it for it's fair market value on the date she passed away. From that starting point, add in any fixing up costs or renovations and the costs of selling, and subtract that total from the sale price to get your gain or loss on the sale.

--Peter
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Thank you Peter for your prompt reply ... which leads to 3 more questions:

1) Should I receive a 1099 (or other document) documenting the net sales amount?

2) Should this transaction be reported on Schedule D as a long term capital gain?

3) Although I believe the answer is no, I'll ask anyway. I will be in the 15% marginal tax bracket in 2014 and therefore my long term capital gains on stocks are taxed at 0%. I will have approximately a $35,000 "cushion" before I am moved into the next higher tier marginal tax bracket. Therefore, will this transaction if recorded as a(LTCG) count towards the $35K cushion, so in effect it will not increase my tax liability?

Thank you again Peter for your help in this matter.

Rich
Arizona
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1) Should I receive a 1099 (or other document) documenting the net sales amount?

Yes. You'll get a 1099-S, although it will be for the gross sales price, not the price net of commissions and other selling costs.

2) Should this transaction be reported on Schedule D as a long term capital gain?

Yep.

3) ... I will be in the 15% marginal tax bracket in 2014 and therefore my long term capital gains on stocks are taxed at 0%. I will have approximately a $35,000 "cushion" before I am moved into the next higher tier marginal tax bracket. Therefore, will this transaction if recorded as a(LTCG) count towards the $35K cushion, so in effect it will not increase my tax liability?

Yes again. The source of the LTCG doesn't matter. Stocks, bonds, houses, cars - all can be LTCG and all get taxed the same.

Don't forget your state income taxes. AZ will tax the gain because you are a resident (I presume, anyway). If the house is also in AZ, that will be that. But if it's in a different state, that state will also get a tax bite at the apple you're holding. Generally, your home state will give you a credit for taxes paid to other states which lessens the potential double state taxation burden.

--Peter
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Peter ~ Thank you so much for the information. It helped me immensely. (I know Phil smiled and gave you a big thumbs up)

Sincerely,

Rich
Arizona
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I know Phil smiled and gave you a big thumbs up

I hope so.

And then he'd chastise me for agreeing that your sale is reported on Schedule D, when it's really reported on Form 8949 and only the totals from the 8949 end up on schedule D.

Whatever, Phil. Whatever. ;-)

--Peter
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For the house you inherited from your mother, it is as if you bought it for it's fair market value on the date she passed away. From that starting point, add in any fixing up costs or renovations and the costs of selling, and subtract that total from the sale price to get your gain or loss on the sale.


Peter,

We too are trying to sell Dad's house, and have been for two years in a declining market. If we ever manage to sell it, it will be at a significant loss. It was his residence, never rented, being split between all us siblings.

Is this loss deductible, or is it like a loss on any non-rental residential property?

TIA,

IP
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Is this loss deductible ...?

That depends. It is certainly possible.

How has the house been used since your father passed away?

--Peter
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How has the house been used since your father passed away?

Sitting empty. Admittedly it's not worth much even with rent, but don't get me started on that.

IP
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Sitting empty.

Let's work by process of elimination. It's not being used personally, so deducting losses is at least a possibility. It's not being held for rent, so it's not business use property. So it must be investment property.

That means the loss would be a capital loss (long term, since it was inherited). I doubt that there is a mortgage on the property, but if there were, the interest would be deductible as investment interest. Property taxes are also deductible. Any maintenance costs (weed clearing, HOA dues, minor repairs) would be deductible as misc itemized deductions subject to the 2% of AGI haircut. Selling costs would go into the calculation of gain or loss on sale, as would any fixing up costs to make the property ready for sale.

--Peter
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That means the loss would be a capital loss (long term, since it was inherited). I doubt that there is a mortgage on the property, but if there were, the interest would be deductible as investment interest. Property taxes are also deductible. Any maintenance costs (weed clearing, HOA dues, minor repairs) would be deductible as misc itemized deductions subject to the 2% of AGI haircut. Selling costs would go into the calculation of gain or loss on sale, as would any fixing up costs to make the property ready for sale.

Interesting. So what does the executor need to get to us to allow us to take the loss? It's all been sitting in limbo waiting for a seller, paying things like taxes and maintenance out of an estate account. Is there something in particular they should do? Can this all just be done on sale of place?

Frankly we are not talking about a large sum of money here, and it will be divided 5 ways, but a loss is a loss.

IP
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One point should be made - if the house is currently owned by the estate, and not by the beneficiaries of the estate, then the gain/loss would be reported directly on the estate's income tax return(form 1041), and not on your(or the other beneficiaries) individual income tax returns.

If the home is sold by the estate, it will also(in this case, but necessarily always) pay any tax due directly.

The estate's executor would then(or eventually) distribute out whatever cash and other assets are remaining to the beneficiaries according to the estate documents(will, etc)

You should check with the executor of the estate to understand the ownership of remaining assets, as well as the schedule for their distribution as well as the tax return filing, etc.
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One point should be made - if the house is currently owned by the estate, and not by the beneficiaries of the estate, then the gain/loss would be reported directly on the estate's income tax return(form 1041), and not on your(or the other beneficiaries) individual income tax returns.

I would suspect it is since we never signed any documents to transfer ownership and the estate is still paying the bills. Would this also mean that the estate would be liable if something happened, and not the siblings who inherit, since no transfer has yet been made? There were very few assets in Dad's estate, most of it being held in a trust.

The loss of tax benefit would be well offset if we can dodge liability. I have no control over what happens with this house since I am not the executor. Getting insurance on the property has been expensive and difficult, harder and harder to convince the others of the need.

IP
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I think the liability depends on who the house was given to in the will. if it was explicitly given to the children(for example) in the will and it is currently owned by the estate as the estate process is sorted through until the property can be distributed out, then the beneficiaries of the estate are liable.
On the other hand, if the estate itself was named as the receiver of the house(and possibly other assets), and then the executor has some control/power to decide which property each beneficiary will receive on dissolution of the estate, then the estate itself would assume liability....
I have some knowledge of these issues, but am not an expert. I strongly suggest you talk to your attorney about these issues. They can be very complex, and can vary for each state....
Another point....
If the house is going to be sold at a loss, then the loss can be absorbed by the estate as well. In that case, it would reduce, or eliminate any tax that the estate has to pay on its own income....
Estate have to file a 1041 if they have income >$600
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Thanks Jalopy. I appreciate it.

IP
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One point should be made - if the house is currently owned by the estate, and not by the beneficiaries of the estate, then the gain/loss would be reported directly on the estate's income tax return(form 1041), and not on your(or the other beneficiaries) individual income tax returns.

That is correct. I sort of implied it earlier when I mentioned that the deductions would be reported on a K-1.

If the home is sold by the estate, it will also(in this case, but necessarily always) pay any tax due directly.

Not so fast. First, they're selling at a loss, so there aren't any taxes to pay in this case.

But more generally, the income taxes will follow the money. If the property is sold at a gain and the proceeds are distributed to the beneficiaries in the same year (or shortly after the end of the year if the fiduciary makes the proper election) then the beneficiaries will pay the income tax. The estate itself pays the income tax only if it holds on to the sale proceeds and doesn't distribute them. (And that's usually a bad idea, as the estate will usually pay more income tax than the beneficiaries would.)

Since we're looking at losses in this case, things are a bit different. Losses get trapped in the estate until the estate is settled and all of the assets are distributed. The loss passes through (along with some expenses) on the final income tax return of the estate.

The estate's executor would then(or eventually) distribute out whatever cash and other assets are remaining to the beneficiaries according to the estate documents(will, etc)

That is a recipe for setting up what are known as throwback distributions. Throwback distributions are complicated, and a great way to end up sending the gain to the accountants instead of to the beneficiaries. I recommend avoiding the situation if at all possible.

--Peter
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Would this also mean that the estate would be liable if something happened, and not the siblings who inherit, since no transfer has yet been made?

That would be a question for a lawyer. The only thing I'm pretty sure of is that insurance would help protect whomever is ultimately liable.

You'd also need to keep an eye on that insurance policy. Typical homeowners' insurance act differently when the home is vacant for long periods of time - and might not cover things you'd expect it to cover. You need to talk to your insurance agent and see what the policy covers in a vacant house, and potentially get a different policy specifically for a house that is frequently vacant.

--Peter
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<<<<
But more generally, the income taxes will follow the money. If the property is sold at a gain and the proceeds are distributed to the beneficiaries in the same year (or shortly after the end of the year if the fiduciary makes the proper election) then the beneficiaries will pay the income tax. The estate itself pays the income tax only if it holds on to the sale proceeds and doesn't distribute them. (And that's usually a bad idea, as the estate will usually pay more income tax than the beneficiaries would.)
>>>>>

Yes, you make a valid point. specifically, if the house is sold and all of hte remaining estate assets are distributed out to the beneficiaries such that the estate can file a final year return, then I agree, the gains/losses would get distributed out to them and they would report on their 1040's. However, if its not a final year return, then the gain/losses would stay in the estate and be included in the estates computation of taxable income. Generally speaking, Capital gains and losses are usually retained in the estate or trust because they are considered "corpus"..i.e. principle. Other types of income like interest and dividends are frequently distributed out to the benes to the extend of distributions.

Bottom line: need to understand the estate documents and should check w/ executor/attorneys/cpa's who are familiar with this particular situation.
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Yes, the vacant nature of the property is what makes it so expensive to buy and difficult to obtain.

IP
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Yes, you make a valid point. specifically, if the house is sold and all of hte remaining estate assets are distributed out to the beneficiaries such that the estate can file a final year return, then I agree, the gains/losses would get distributed out to them and they would report on their 1040's. However, if its not a final year return, then the gain/losses would stay in the estate and be included in the estates computation of taxable income.

No.

As I said, follow the money. The estate does NOT have to be final for income and/or gains to flow out to the beneficiaries. It just has to make distributions to the beneficiaries. Those distributions do NOT have to be all of the estate's assets. They can be partial distributions and the estate can remain open.

Losses and deductions are different. It is possible for those to get stuck inside the estate and only pass through on a final return.

--Peter
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The key to understanding how inherited homes get taxed is understanding the calculation of basis. Basis refers to the cost of the asset for the purpose of calculating capital gains and other taxes.

When someone dies, the IRS increases the property's basis up to its fair-market value at the time of the person's death. In other words, if someone bought a house 30 years ago for $50,000 but it was worth $200,000 when they died, the IRS would value the house at $200,000 for capital gains purposes.

If you turned your inherited home into an investment property, you won't be able to take advantage of the IRS' favorable treatment of gains on personal residences, and you'll need to pay capital gains taxes. However, you'll only pay capital gains taxes on the difference between your final selling price and the stepped-up basis at which you inherited the property.

Unless the property goes up in value very quickly or you hold the home for a long time, you most likely will have very little tax liability. One thing to be wary of is that if you hold the home for less than one year after inheriting it, your gain may be treated as a short-term capital gain instead of a long-term gain. Short-term gains are taxed at higher rates than long-term gains.
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Yeah, I am not worried about paying a tax on gains...the property has lost about 15% of it's value since Dad died. I am just curious about taking advantage of the loss. The area is in tough shape. House is down to $55K and it is still not selling: http://www.realtor.com/realestateandhomes-detail/330-Tessent...

Location, location, location...or in this case lack thereof. I've suggested more than once just donating it to the local church.

IP
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One thing to be wary of is that if you hold the home for less than one year after inheriting it, your gain may be treated as a short-term capital gain instead of a long-term gain.

No.

Inherited property is always long term. Doesn't matter how long you hold it after inheriting.

--Peter
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