Does my deceased mother's house count as inherited if I am listed on deed with rights of survivorship and how will the profits on the sale of the house be taxed?

[paro_4eva]

My mother purchased a primary residence home for herself in 2018 for $200k.

When she was diagnosed with terminal cancer in February 2022, she added my sister and me to the property deed as joint tenants with rights of survivorship (we never lived there, let us assume that the property was worth $280k in February 2022). She passed away in June 2022 (let us assume that the property was worth $290k in June 2022) and we are selling the house for $300k in August 2022.

How will the profits on the sale of the inherited house be taxed?

1. taxable as long-term capital gains on full appreciation from the purchase price in 2018 ($300k - $200k = $100k LT capital gains)
2. taxable as short-term capital gains on the appreciation from the time that we were added to the deed? ($300k - $280k = $20k ST capital gains)
3. taxable as short-term capital gains on the appreciation from the time that my mother passed away? ($300k - $290k = $10k ST capital gains)
4. untaxed because of the six-month "alternate date valuation" rule (I.R.C. § 2032(a)(1))?
5. something else?

If the answer is #2 or #3, do we simply do our best to estimate the value of the house at the time that we were either added to the deed or at the time that my mother passed away? or is there a more formal appraisal required?

[tagteam · Accepted solution]

I am sorry for your loss.

The only type of appraisal the IRS has to accept is one conducted by a certified real estate appraiser where the valuation (fair market value) date is the date of death.

You should consult with a local tax professional because there is indicia here of a retained (implied) life estate, per Treas. Reg. §20.2036-1(c).

See https://www.law.cornell.edu/cfr/text/26/20.2036-1

In that event, the basis for you and your sister would be the full fair market value on the date your mother passed (with a long-term holding period since the interest was acquired from a decedent).

Again, consult with a local tax professional so the matter is handled properly.

See https://taxexperts.naea.org/listing/service/estates-gifts-trusts

[Opus 17]

You do need to see a professional.  Let me dig into the weeds for you to show you why.

(Minor note: Inherited property is considered long term property, because you also "inherited" the previous owner's holding period. So any gain per below will be long term gain.)

Now, as to the cost basis, there are two ways to calculate it.  Under a joint tenancy, each sibling was given 1/3 of the property in February and inherited 1/6 of the property in June.   Let's assume your mother's cost basis (her cost plus improvements) was $200,000.  That means each sibling was given 1/3 of the property with a basis of $66,666, and then on your mother's death, each sibling inherited 1/6 of the property with a cost basis of $48,333 (1/6 of the FMV of $290,000).  So your total cost basis is $115,000 per sibling.  If you sell for $300,000, each sibling has a taxable capital gain of $35,000.

Note that your mother may be required to file a gift tax return for giving you 1/3 of the home.  For a gift given in 2022, the gift tax return must be filed by April 15, 2023.  This is a separate form not included with Turbotax.  A payment of gift tax is unlikely but the form must be filed.  This will be the responsibility of whomever is your mother's personal representative or executor and who will be filing her regular income tax return. 

To reduce your capital gains, you want to carefully document your mother's cost basis.  This will be what she paid for the home plus what she paid for permanent improvements.  If she owned the home with a spouse who passed away before the gift date in February 2022, she will get some kind of basis adjustment depending on what state you live in.  Some of her closing costs from the purchase can also be included in her basis, see publication 523, page 8. 

If you had a life estate, however, then you inherited the home with a fully stepped up cost basis equal to the FMV on the day your mother died.  You seem to not have a written life estate, but you may have an implied life estate, which the IRS might recognize, and then your cost basis would be $145K per sibling and your gain $5K per sibling.  (You may be able to use the alternate date rule, in which case you would have no gain.  But I am not an expert on the use of this rule.)   Also remember that certain selling expenses are adjustments to your gain, including the real estate commission and certain taxes and fees, as listed in IRS Publication 523 on page 8. If the $300K is the gross selling price, you can probably reduce your gain significantly just from allowable adjustments and selling expenses.  https://www.irs.gov/pub/irs-pdf/p523.pdf

So, you will really benefit from a professional who can help determine if you have an implied life estate, and thus low or no capital gain.  If you can't show an implied life estate, the professional can help you determine your mother's cost basis and your allowable adjustments so you can claim the highest cost basis and lowest taxable gain possible.  

[tagteam]

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@Opus 17 wrote:

.....(You may be able to use the alternate date rule, in which case you would have no gain.  But I am not an expert on the use of this rule.)

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True. Per Section 2032, in order to elect the alternate valuation date, both the value of the gross estate and the amount of estate tax due must be decreased. As a result, the alternate valuation date is typically only elected with respect to very large estates.

Further, in the case of a life estate (either expressed or implied), there is no need to use an alternate valuation date (in fact, it cannot be elected) since the remainder passes to the remaindermen by operation of law (i.e., it passes outside the estate).

[tagteam]

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@Opus 17 wrote:

....If you can't show an implied life estate.

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The key word is "implied", which means derived from the circumstances (or does not have to be "shown").

Here, it should not be problematic to imply the right to the remainder from the circumstances (i.e., mother executes a deed following a terminal diagnosis and dies several months thereafter). This would be the best outcome for @paro_4eva.