Adjusted cost basis for an inherited primary residence with a lien

[kwispy]

Hi all,

My father owned his primary residence in joint tenancy with me. About a decade ago, he applied for a state program that helps seniors postpone their property taxes, whereby the state places a lien on the property and pays the property taxes to the county government. To be clear, this is not a property tax lien imposed for delinquency on property taxes. Rather, this is a senior assistance program (with certain required qualifications and an application process) that they do not specifically call a loan.

He recently passed, and his 50% ownership transferred to me via the joint tenancy. I'm interested in selling the house.

1. Would the outstanding balance increase the home's adjusted cost basis?
2. Does it matter that the postponement was in his name and that I inherited the property with this encumbrance?

Thank you all

[tagteam]

You should seek guidance from a tax professional in your state as state law may be applied differently.

However, if the lien is in the nature of a loan, then that would not factor into the adjusted basis (half of which would be stepped up to fair market value on the date of your father's passing).

I am sorry for your loss.

[kwispy]

Thank you for your response. Rereading their website, it looks like they specifically do not call it a loan. It is considered an assistance program requiring specific applicant qualifications that is merely secured by a lien. I'm wondering if this may be considered something else.

[Critter-3]

1. Would the outstanding balance increase the home's adjusted cost basis?  NO... you get a step up in basis. 
2. Does it matter that the postponement was in his name and that I inherited the property with this encumbrance?  No it doesn't make a difference. 

[Opus 17]

One further note. I assume that the back due property taxes will be deducted from the sales proceeds. This is not a deductible expense to you, nor does it reduce the sales proceeds, allowing you to claim a smaller capital gain or a capital loss. You would be allowed to deduct on your tax return, only the property taxes that apply to the period of time when you owned the home, between your father’s death and the sale of the house.

You received a stepped up basis when your father passed, your adjusted cost basis in the home is the fair market value of the home on the date he died. You may want to secure a real estate appraisal to prove this in case of audit.  When you sell the home, you can deduct certain selling expenses, (such as real estate transfer taxes and the commission) from the proceeds, but you can’t deduct these past due taxes. Assuming the real estate market doesn’t change two months too much in the short time between your father‘s passing and selling the house, you will likely sell the house very close to its fair market value, so that once you subtract the sales commission, you might even have a slight loss. If you treat this as a personal home, the loss is not deductible, but if you treat it as investment property, the loss is tax deductible. 

[tagteam]

Per Section 164, real estate taxes are deductible in the tax year in which they are paid.

https://www.law.cornell.edu/uscode/text/26/164

[Opus 17]

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@tagteam wrote:

Per Section 164, real estate taxes are deductible in the tax year in which they are paid.

https://www.law.cornell.edu/uscode/text/26/164

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It is my understanding that real property taxes are only deductible when paid by the person against whom they are assessed.  In this case, the taxes were assessed against the father.  If the father had sold the property, the father certainly could have deducted them when paid.  But the child can't deduct taxes that were assessed to the father and apportioned to the time when the father owned the home.

My justification for this argument is in general, the rules for allocating the property taxes when property is sold (see publication 523 page 17. https://www.irs.gov/pub/irs-pdf/p523.pdf)

And more specifically, 26 CFR § 1.164-1 and § 1.164-6

https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFRc4930337f38ecf...

Specifically paragraph § 1.164-1(a)

"In general, taxes are deductible only by the person upon whom they are imposed. "

and paragraph 1.164-6(d)(3)

"Persons considered liable for tax. Where the tax is not a liability of any person, the person who holds the property at the time the tax becomes a lien on the property shall be considered liable for the tax."

[tagteam]

Section 1.164-6 addresses apportionment between sellers and purchasers and is inapposite for the purposes of this thread.

You misstated Section 1.164-1(a), which reads as follows:

§ 1.164-1 Deduction for taxes.

(a) In general. Only the following taxes shall be allowed as a deduction under this section for the taxable year within which paid or accrued, according to the method of accounting used in computing taxable income:........

There is no requirement that real estate tax must be "imposed" upon the person (who is an owner of the real estate) before the tax paid is deductible. In fact, you should take note that real estate taxes are never imposed upon a person or owner; such taxes are assessed and become a lien on the real estate itself, not any particular individual.

The yield out of all of the foregoing is that anyone with any type of an ownership interest in the property can deduct any real estate taxes assessed in the tax year in which that person pays the real estate tax.

[Opus 17]

The entirety of 164.1(a) reads:

In addition, there shall be allowed as a deduction under this section State and local and foreign taxes not described in subparagraphs (1) through (5) of this paragraph which are paid or accrued within the taxable year in carrying on a trade or business or an activity described in section 212 (relating to expenses for production of income). For example, dealers or investors in securities and dealers or investors in real estate may deduct State stock transfer and real estate transfer taxes, respectively, under section 164, to the extent they are expenses incurred in carrying on a trade or business or an activity for the production of income. In general, taxes are deductible only by the person upon whom they are imposed. However, see § 1.164–5 in the case of certain taxes paid by the consumer.

The taxes were never imposed on the offspring.  If the child bought the property from the father, the child could not deduct the back taxes.  If a stranger bought the property from the father, the stranger could not deduct the back taxes.  It is unclear why inheriting the property would be different in how the taxes are apportioned.  

The seller may want to consult their own local expert.

[tagteam]

You're reading the section wrong; what you quoted is called "flush language" which explicitly states in the very first line, "In addition to........subparagraphs (1) through (5)" and then goes on to address other types of taxes.

Again, there is no requirement that real estate tax be levied on anyone with an interest in property before the taxes paid are deductible in the tax year they are paid. It is irrelevant that the taxes were never imposed on the "offspring" as that person has an ownership interest in the property and, without payment thereof the tax lien could be foreclosed and the property sold.

I'm really not sure why you're arguing this point as it is fairly well-settled. 

[kwispy]

Hi all,

Thank you for the responses. My question is focused specifically on the adjusted cost basis of the home; I don't have questions about the personal deductions for taxes paid, etc.

It sounds like the state assistance program is commensurate to a tax lien such that the balance may be considered back taxes. If so, it sounds like there's no basis adjustment. Moreover, I believe the step-up in basis only steps up half of the property since it was held in joint tenancy with me.

Thank you

[tagteam · Accepted solution]

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@kwispy wrote:

It sounds like the state assistance program is commensurate to a tax lien such that the balance may be considered back taxes. If so, it sounds like there's no basis adjustment.

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If that is the case, then the taxes would be deductible in the tax year in which you pay (or paid) them and there would be no basis adjustment.

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@kwispy wrote:

....I believe the step-up in basis only steps up half of the property since it was held in joint tenancy with me.

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Correct; the one-half you acquired from your father is stepped up to its fair market value.

[AmeliesUncle]

This is an interesting discussion about the how the tax is "imposed".

I was taught exactly as Opus said - the tax is "imposed" on the owner, and is therefore taxes from a prior owner are not a deduction as property tax when paid.  But because of that, it is a 'cost' of acquiring the property, so it WOULD be added to Basis (at least if you were to purchase a property that had a lien for real estate taxes; inheriting a property that you already partially own could be different).

But I guess I never really looked into it, so I'm unsure what is correct.  @tagteam , do you by chance have any citations that show the tax is imposed on the real estate itself, rather than the owner?  Or possibly it could vary by location???

[tagteam]

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@AmeliesUncle wrote:

....I'm unsure what is correct.  @tagteam , do you by chance have any citations that show the tax is imposed on the real estate itself, rather than the owner?  Or possibly it could vary by location???

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State law controls, but that would be exactly the same in all states. The local taxing authority, typically the county, is authorized by state law to levy a tax (ad valorem) against real estate within its jurisdiction. Such taxes are never "imposed" on the owner(s) of the real estate, and they virtually are never subject to personal liability for paying (or not paying) the tax levied. The only recourse the county has is a lien against the property itself (i.e., essentially nonrecourse in terms of the owner(s)) and foreclosure of that lien. 

The other issue would be who pays as between the seller and purchaser of the property (which was cited earlier in this thread as Section 1.164-6 delineates the apportionment for federal income tax purposes). That, however, is a different issue than the issue at hand since @kwispy was an owner of the property and continues to own the property; there has not been a sale, according to the facts set forth.

Regardless, I fail to see where the issue here differs from the issue where an owner of real estate (any real estate) fails to pay the tax for a year or more and then finally pays in, for example, the third year (i.e., pays three years' worth of property taxes). That total payment would be deductible in the tax year in which payment is made (assuming a cash basis taxpayer).

[AmeliesUncle]

Interesting.  Thanks for the information.