The $250,000 exclusion is based on the gain. Selling price of the house minus (what you paid /or cost basis plus improvements).
- If you are in a community property state, your cost basis is adjusted as mentioned above.
- If not, the basis is calculated for each of you. For example:
- Purchase for $500,000, each of you have basis of $250,000
- Improve the house $100,000, each of you have basis plus improvement of $300,000 ($600k combined)
- Spouse dies, house worth $1M - spouse half of house now has a basis of half a million (instead of the $300k) for the inheritor(s) to use.
If the spouse inherits that half of the house:
- inherited value $500,000 from deceased
- plus owner's basis from above of $300,000
- has a new basis of $800,000.
- Sell for $1.1M,
- gain of $300,000
- minus the $250,000 exclusion
- leaves a taxable gain of $50,000.
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