When a life estate property is sold before the life tenant dies, there is no "step-up" in basis and capital gains are paid based on the original purchase price of the property with adjustments for improvements that haven't been deducted. The resulting capital gain is divided between the life tenant and the remaindermen based on IRS actuarial tables.
If the life tenant lived in the home for 2 of the 5 years prior to the date of sale, he/she may take advantage of the $250,000/$500,000 capital gains exclusion on his/her portion of the gain. Only the life tenant may take advantage of the exclusion, as he/she is the only person living in the home.
There is a special clause in the tax code regarding the "2 of 5" residency requirement if the life tenant moves to a licensed nursing facility. Section 121(d)(7) states that if the individual “becomes physically or mentally incapable of self-care” and resided in the home for periods of time that, in aggregate, equal at least 1 year out of the past 5, “then the taxpayer shall be treated as using such property as the taxpayer’s principal residence during any time during such 5-year period in which the taxpayer owns the property and resides in any facility (including a nursing home) licensed by a State or political subdivision to care for an individual in the taxpayer’s condition.”
**Answers are correct to the best of my ability but do not constitute tax or legal advice.
