Further complications I forgot the first time.
If the mother-in-law co-owned the home with her spouse who died, that creates another adjustment to the cost basis, and it also depends on whether she lived in a community property state. This adjustment increases the cost basis so it reduces your gain and is in your favor, so you will not want to ignore this adjustment.
If not in a community property state, your mother-in-law inherited half the house from her spouse when he died, giving her a boost in her basis based on the fair market value at the time. Suppose the home was purchased for $20,000. Each spouse has a $10,000 share of the basis. Then, suppose the home was worth $100,000 when her spouse died. She inherits his half, valued at $50,000, so her basis is now $60,000. That's the basis she gave to you (plus improvements), not the $20,000 basis. But you will need to document the fair market value on the date her spouse died. A real estate appraiser can give you a retroactive appraisal based on historical records.
If they lived in a community property state, she gets the full stepped up basis ($100,000 in my example) instead of half the stepped up basis.
