How to enter full step-up in cost basis for sale of 2nd home in community property state

[kritter-k]

My husband and I (actually, our revokable Trust) owned a second house in AZ. We never lived in the house. My parents lived there rent-free. We never claimed any deductions or charged any rent. My husband died in March 2024 and I sold the house in Dec. 2024. I have since moved to a state that is not a community property state.

I know I cannot claim an exclusion for any gain because the house was not our primary residence. However, I've been told that I can get a full step-up in cost basis to the value of the house on the day my husband died because AZ is a community property state. Is that correct?

If it's correct, how and where in the TurboTax software do I enter that info? There's a place to enter the selling price but when I used the "Easy Guide to Help Calculate the Adjusted Cost Basis," there was nowhere to enter the value of the home on the day my husband died.

Also, according to my calculations, if I get a full step-up in cost basis, I won’t have any gain; I’ll actually have a loss. I know I can’t claim a loss. Will it look suspicious and trigger an audit if I report zero gain since I cannot claim a Section 121 exclusion?

[MaryK4]

Yes, because it is an equal and undivided interest, all community property receives a basis step-up upon the death of the first spouse. You will enter the fair market value on the date of his death as the basis.  If there is a loss, you would not be required to report it.  Why do you think it looks suspicious enough to trigger an audit?  There are losses reported and realized everyday,  Keep the records to prove the value in case you get audited.

[kritter-k]

Thanks for your reply. Where in the TurboTax software can I enter as the basis what the FMV was on the date of his death?  There's a place to enter the selling price but when I used the "Easy Guide to Help Calculate the Adjusted Cost Basis," there was nowhere to enter the value of the home on the day my husband died.

I'm worried about a loss on the second home looking suspicious because I also sold our primary home a couple of months before selling the second home, and I took the exclusion for that. So I had no taxable gain on the primary home either.

[kritter-k]

I think I found how to enter the step-up in cost basis in the TurboTax software.

1. Enter the actual sale price in Selling Price.

2. Enter any sales expenses in Sales Expenses.

3. Click Continue.

4. On the Tell Us About the Purchase of Your Home screen, click the EasyGuide button to calculate the Adjusted Cost Basis.

5. On the Adjusted Cost Basis Easy Guide screen, enter the Original Cost and misc other fees. 

6. Click Continue.

7. On the next screen, answer whether the seller paid any points or loan origination fee.

8. You will eventually get to a screen that asks you to enter Permanent Improvements, Cost of Home Additions, and Special Tax Assessments. Enter those and click Continue.

9. Keep going through the EasyGuide screens until you get to the screen that says “Enter the description of any other items that increased the cost of your home…For example: You received part (or all) of the home through an inheritance or a divorce…” 

a. In the Description of Increase field, enter a description such as “Step-up in cost basis due to death of spouse.

b. In the Amount field, enter the difference between the Original Cost and the FMV of the house on the day your spouse died (for example, if Original Cost was $222,000 and the FMV was $461,000, enter $239,000). 

c. Click Continue.

10. Enter a description and cost for any items that decreased the cost of the home.

11. Click Continue.

12. The final EasyGuide screen will show the value you entered for Permanent Improvements. It will also show, in the Other Increases field, the adjustment for the step-up in cost basis that resulted from entering the value you entered in step 9b. The sum of these two values is shown in Total Increases field, and the value that reflects the effect of all the increases is shown in the Adjust Basis field.