Form 1041: Sale of house - calculating gain/loss and deducting property taxes

[Trust2024]

I live in California and am using TurboTax Business 2023 to file a first and final fiduciary tax return (Form 1041) after the death of my mother (last parent).  She owned a house in a revocable trust.  I sold the house 4.5 months after she died.  It is my understanding that the house gets a step-up in cost basis at her date of death.  My trust attorney told me that if the house was sold within 6 months, I can use the sale price as the cost basis and no appraisal would be necessary.  I have the following questions:

1)  Since the house was sold 4.5 months after the date of death, the sale price would be the same as the cost basis resulting in no capital gain.  Since  there is approximately $100,000 in deductible selling expenses, does this mean there would be a loss of $100,000 and that this loss would be passed on to the beneficiaries in their K-1's since this is the final fiduciary tax return?

2) At my mother's date of death, the county re-valued the house for property tax purposes.  We received a new property tax bill based on the higher value of the house for the time period from the date of death to the closing date of the sale.  Is this property tax amount deductible on Form 1041 as local taxes?

Thank you in advance for anyone answering the above two complicated questions.

[tagteam]

Your attorney is conflating the following alternate valuation date for estate tax purposes with the step up in basis.

In the case of property distributed, sold, exchanged, or otherwise disposed of, within 6 months after the decedent’s death such property shall be valued as of the date of distribution, sale, exchange, or other disposition.

See https://www.law.cornell.edu/uscode/text/26/2032

The best evidence of fair market value, and the only one the IRS must accept, is an appraisal by a certified real estate appraiser. 

[Critter-3]

First the real estate agent you just used should be able to give you an evaluation to use for the DOD basis however I have always used the sale price if sold "close" to the DOD as that is the actual price a willing buyer is willing to pay.  Add the closing costs to that basis then you will have a loss in the amount of the closing costs to pass thru to the beneficiaries.  I have never seen an IRS letter on cost basis in the 30+ years I have been in business but keep all the paperwork just in case you do get one. 

[tagteam]

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@Critter-3 wrote:

.....I have never seen an IRS letter on cost basis in the 30+ years I have been in business but keep all the paperwork just in case you do get one. 

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Nor have I, except I have seen valuation issues with respect to estate tax returns. For a 1041, though, it's a long shot that the basis reported would be questioned unless it's totally out of whack. 

[Trust2024]

Thanks to tagteam and Critter-3 for your answers to my questions. Following up on your answers, I did some further research on the topic of taxes on an inherited house. In my case, the house was held in a revocable trust. I will summarize my understanding of taxes on an inherited house related to my original questions:

1) The first issue is the step-up in cost basis of the house when the owner dies. Under IRC Section 1014 assets received from a decedent are afforded a basis step-up to the fair market value (FMV) of the property at the date of the decedent's death (irrevocable grantor trusts are excluded under ruling 2023-02). How FMV is determined has been interpreted in different ways. As tagteam has mentioned, the IRS will accept an appraisal of the property on the date of death by a licensed real estate appraiser as FMV. A second possible determination of FMV is to sell the house immediately after the date of death. The IRS may accept the sale price as the cost basis depending on how much time has passed between the sale and date of death. A third way of determining FMV is to use a supplemental property tax bill sent by the county stating the assessed value on the date of death.

There are disadvantages of using all 3 methods. Getting a retroactive appraisal from an appraiser may not reflect the actual value of the property as it is only as good as the data used for the appraisal. Using the sale price for cost basis runs into the problem of how soon after the date of death the property is sold and how quickly the house has increased or decreased in value in that time. Using a supplemental property tax bill as FMV depends on the accuracy of the county assessor's valuation.

2) In selling an inherited house, capital gain or loss is calculated by subtracting the cost basis from the sale price reduced by deductible selling expenses. If a house is sold quickly after the date of death, it is likely that there will be a loss due to the nearly identical sale price and cost basis and deducting selling expenses. In the final year of Form 1041, any loss is passed on to the beneficiaries on the K-1's for their tax benefit.

3) The inheritor of a house will receive a supplemental property tax bill from the county for the period between the date of death and the closing date of the sale of the house. This tax bill is based on the newly assessed value of the house on the date of death. The amount of property tax can be used as a deduction to taxable income on Form 1041.