Capital Gains Issues on Inherited Property

[ruralakay]

Hi! My father passed away in December. He left his home to me and my 2 siblings. We chose to sell it and, after 5 mths on the market, we finally sold it for less than we thought we would. We are closing tomorrow. I'm trying to figure out our capital gains situation. Here are the specifics: 1. We did not have an appraisal done at time of death (was last thing on our minds). The county appraisal district reported a tax value in 2023 of approximately $227k. For 2024, it was approx $240k. The CMA from the realtor assesses a comparative value of around $240k-$250k, compared to similar homes in his neighborhood/area. I don't know which to use to determine FMV at time of death. 2. The selling price is $235k. On the closing documents, they have the mortgage payoff ($110k) figured into the closing costs (along with the closing costs), listing a net proceeds of around $104k (divided by 3 siblings). 3. We also did around $2000 in qualified improvements, as a good faith gesture to get the buyer to commit. So, do we use the net proceeds, as reported in the closing documents, or subtract the mortgage payoff first? Any scenario will result in a capital gains loss, but with mortgage payoff included, it is a HUGE loss. Can't find anything online that addresses this type of scenario. 

[ruralakay]

I should have said "nothing online addressing this SPECIFIC scenario."

[tagteam]

First of all, before anything else, you cannot use the mortgage payoff (loan balance payoff) to increase the capital loss. The loan balance does not factor into the gain/loss calculation.

The basis would be the fair market value on the date of death plus the cost of any improvements made since that date. 

The CMA should suffice but prudence dictates using the lower figure ($240k). The county property appraisal is for property tax assessment purposes and typically is not a highly accurate indicator of market value.

I am very sorry for your loss.

[tagteam]

---

@ruralakay wrote:

I should have said "nothing online addressing this SPECIFIC scenario."

---

@ruralakay 

This is an extremely common scenario where a decedent's real property is valued at the fair market value as of the date of death and the heirs receive the property with that basis (and sometime later sell the property, many times at a loss due to selling expenses and the cost of improvements).

You would simply take your $235k gross selling price and subtract the selling expenses (most likely real estate broker commissions) to arrive at the sales price to be used for the purposes of calculating gain or loss.

From the resulting figure, rounding it off to around $223k, you would subtract your basis of $242k (the FMV on the date of death plus the $2k cost of improvements). Roughly, there would be a $19k capital loss on the sale.

Note that if one of the heirs (beneficiaries) used the home for personal purposes, no loss can be recognized.

[ruralakay]

Thank you for your quick and kind response. That was the answer I was looking for. It didn't seem appropriate to use the $104k net proceeds figure, because that would have us carrying over the loss for the next 12-14 years. I wish the title company and realtor had placed the mortgage payoff somewhere else on the document than lumping it into the closing costs. Thanks again. 

[Opus 17]

---

@ruralakay wrote:

Thank you for your quick and kind response. That was the answer I was looking for. It didn't seem appropriate to use the $104k net proceeds figure, because that would have us carrying over the loss for the next 12-14 years. I wish the title company and realtor had placed the mortgage payoff somewhere else on the document than lumping it into the closing costs. Thanks again. 

---

You just need to look at the selling price.  If the contracted selling price is $235,000, that's the selling price, regardless of any other adjustments or the amount of the mortgage.  (Remember, that if you sell for $235,000 but the proceeds are only $100,000, that's because the previous owner borrowed a lot of money on the house that wasn't taxed at the time and never paid it back prior to the sale.)

Then you can subtract the commission and certain of your other closing costs (maybe, see the list in publication 523 https://www.irs.gov/forms-pubs/about-publication-523)

Be careful about the difference between improvements and repairs.  You can increase the cost basis by the cost of improvements but not repairs.  Again, see publication 523 for a discussion of this topic. 

If audited, the tax assessment would be considered the least reliable determination of FMV, because assessments are rarely 100% accurate.  I agree the lower range of the CMA is possibly ok.  A third argument, even more conservative, would be that, unless the market changed a lot in 5 months, the FMV was probably the same as the eventual selling price.  (The selling price is the ultimate proof of FMV, assuming the seller and buyer are unrelated, and the house was publicly listed.  And if the FMV at the sale was $235K, it was probably the same or lower in December.)  Even using the selling price as FMV would create a small tax loss once you include your improvements and the commission.  

[tagteam]

---

@Opus 17 wrote:
I agree the lower range of the CMA is possibly ok.

---

It's absolutely OK provided the date of death was used as the point in time for the CMA.

If it was sometime later, then @ruralakay could simply request the broker (agent) to use the date of death for the CMA.