Home was in a Life Estate

[MWQ]

My parents purchased a home back in 1988 and it was their primary residence. They put my brother and I on title to the home in 1999 and put it in a life estate. Both parents have passed away and my brother and I just sold the home this month.  My question is how is this taxed ? I know it’s capital gains but is our cost basis what my parents paid for it in 1988 or is it the value of the home when we were added to title in 1999?  Thanks 

[SwapnaM]

This will be treated as an inheritance. You will receive a stepped-up basis in the property.
The cost basis is the fair market value (FMV) of the home at the date of the last parent’s death, not the 1988 purchase price or the 1999 title change. This means that your cost basis resets to the FMV rather than the original purchase price, reducing future capital gains taxes when the property is sold.

If the home was worth $500,000 when your last parent passed away, and you sold it for $520,000, your capital gain would be: 

$520,000 (sale price) – $500,000 (stepped-up basis) = $20,000 capital gain
This gain would be split between you and your brother (assuming 50/50 ownership), so each of you would report $10,000 in capital gains.

https://www.irs.gov/publications/p544#en_US_2024_publink100072269 is an authoritative source for Basis information.

@MWQ Thanks for the question!!

[MWQ]

Thank you but I am confused. How can it be treated as an inheritance when we legally owned it as of the date we were put on title to the house? 

[SwapnaM]

Even though you were added to the title in 1999, your parents retained a life estate, which means they kept the legal right to live in and control the property until their deaths. You had a future interest in the property, not full ownership.

Because of the life estate, you get the step-up in basis to the fair market value at the date of the last parent’s death, which significantly reduces or eliminates capital gains tax when you sell.

@MWQ Thanks for the question.

[MWQ]

Thanks so much