Inheritance-adjusted vacation home value

Q: I’m an 84-year-old man trying to wind up his financial affairs to make things easier for my children after I pass away. My wife died in 2016 and I lived alone for five years. I sold my main residence last year and moved into a detached residence, and am now under contract to sell my last significant property, which is a mountain “getaway” property. My wife and I bought the property in 2007 for $240,000 and I will sell it for $539,000. The documents I have prepared for the title company include a statement on the use of the property. I have verified that I am not using the property as my primary residence, which is true. My broker tells me that I will receive a 1099-S indicating the sale proceeds. My broker says he doesn’t know what this means for the taxes I will owe. It is certain that I will owe taxes. I assume that I will be allowed to deduct the sales commission and other closing costs. If so, should I subtract the $240,000 cost? One thing that worries me is that I can’t find the settlement statement that shows I spent $240,000, but I’m sure that’s what we paid. Will the IRS require me to prove it? What if I can’t? And will all of this be capital gain income?

A: This sale will need to be reported on your 2022 tax return. Because this was a vacation home, you will need to report the gain from the sale as a capital gain on IRS Schedule D.

You will report a sale price of $539,000. This number will then be mapped to the 1099-S you will receive. The gain is the difference between $539,000 and your tax base in the property.

It is generally the taxpayer’s responsibility to prove the tax base. Your concern about the settlement statement would often be a problem. Since your wife died after you bought the house, you won’t need to prove what you paid.

When you inherit property, your tax base is adjusted to the fair market value (FMV) on the date of death. I assume you and your wife held this house as common property until she died.

You inherited the community share of your wife’s property when she died. The tax law has a special basic rule for community property that allows for an adjustment of the tax base at FMV for the entire property.

This means that your tax base becomes the FMV of the house in 2016 on the date of your wife’s death. This is so regardless of what you paid for the property in 2007.

The selling expenses recorded on the 2022 statement will be added to this 2016 adjustment of the tax base.

Selling costs are those incurred because you sold the property. The prorated property taxes you are charged do not count, as you are liable for the taxes whether or not you sell.

This analysis does not solve your basic worries. It just means that the problem shifts from what you paid in 2007 to what the property was worth when your wife died.

To be sure we’re on the same page, let’s say the house was worth $425,000 when your wife died and the cost to sell is $40,000. That would make your tax base $465,000.

Your tax gain in 2022 would then be $74,000 ($539,000 – $465,000). This gain is much lower than if you had been forced to use the 2007 purchase price.

As a single taxpayer, your capital gains rate will likely be 15% for federal tax purposes. The rate is zero up to $41,675 of taxable income.

If you have other income in 2022 that reaches $41,675 after the standard deduction or itemized deductions, your capital gains rate will be 15%.

I just created the JVM in the example above. You may want to ask your broker to help you estimate the value as of the date of your wife’s death.

However, the FMV adjustment will remove much of the tax burden that you may have expected.

Jim Hamill is the Tax Practice Manager at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected]

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