Capital Gain or Loss on Sale of house

What is the name of your state? CA

My siblings and I inherited a house that was in my Father's Trust and subsequently passed on to us.

At the time of Death, the house was appraised for $375,000. There was a life estate, that person died last year, and the house was transferred to us this year, 4 years after the death. At the time of transfer, we had it appraised and the value was $525,000.

Question is, what is our cost basis? $375,000 or $525,000? Since we did not technically own the house until 2 months ago, wouldn't that make our cost basis what the house was worth at the time of transfer?

Thanks much for any insight.

Kenny

gapdev said:

What is the name of your state? CA

My siblings and I inherited a house that was in my Father's Trust and subsequently passed on to us.

At the time of Death, the house was appraised for $375,000. There was a life estate, that person died last year, and the house was transferred to us this year, 4 years after the death. At the time of transfer, we had it appraised and the value was $525,000.

Question is, what is our cost basis? $375,000 or $525,000? Since we did not technically own the house until 2 months ago, wouldn't that make our cost basis what the house was worth at the time of transfer?

Thanks much for any insight.

Kenny

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Since ownership of the house did not effectively transfer to you until two months ago, your basis is FMV as of 2 months ago.

However, I have seen this argued differently. I have seen it argued that your basis would be 375,000 plus the value of the life estate. However, that should work out to be approximately the same as FMV at the date of death of the person with the life estate.

I would disagree. In general the basis steps up on the date of the death REGARDLESS of when the property is actually transferred. There is a provision for an alternate valuation date, but by and large it doesn't help (essentially, while it's helping the estate it's worse for you as the heir). DEATH is what gives you the basis, not the property transfer. If he had trasfered it to you before his death, you'd not get any step up.

FlyingRon said:

I would disagree. In general the basis steps up on the date of the death REGARDLESS of when the property is actually transferred. There is a provision for an alternate valuation date, but by and large it doesn't help (essentially, while it's helping the estate it's worse for you as the heir). DEATH is what gives you the basis, not the property transfer. If he had trasfered it to you before his death, you'd not get any step up.

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I don't know anything about taxes (except that I pay enough of them to support a small country).

But isn't it important about how the place was titled?

If it was in a trust, then the trust owned it both before and after pa's death.

seniorjudge said:

If it was in a trust, then the trust owned it both before and after pa's death.

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Depends what the trust was, but if it is the common revocable living trust that many people use, then the basis issues are the same as if it had been personally held by the decedent.

FlyingRon said:

Depends what the trust was, but if it is the common revocable living trust that many people use, then the basis issues are the same as if it had been personally held by the decedent.

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Thank you.

I have learned something today.

FlyingRon said:

I would disagree. In general the basis steps up on the date of the death REGARDLESS of when the property is actually transferred. There is a provision for an alternate valuation date, but by and large it doesn't help (essentially, while it's helping the estate it's worse for you as the heir). DEATH is what gives you the basis, not the property transfer. If he had trasfered it to you before his death, you'd not get any step up.

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Sorry, but this one is one that my firm has researched to death. I stand by my previous answer. The inheritance doesn't effectively take place until the person holding the life estate dies or abandons that life estate. Therefore the value of the life estate is a cost that gets added to the basis...which makes it effectively the FMV as of the date of the person holding the life estate.

The title of the property stayed in the Trust until it was transferred from the Trust to us, the children. It was a revocable trust.

The Life Estate belonged to 2nd wife. She died last year and it took a year to determine whether property went to the trust or to the children. Court ruled that it goes directly to the children.

The Life Estate did not benefit the siblings in anyway, other than the property appreciated while the wife lived there.

My concern is that since we took ownership 2 months ago, that would make it a short term capital gain, yet the basis at time of death would be from 4 years ago. However, if the basis is from when title was transfered to us, that makes for a negative capital gain (we sold it for less than appraised value).

My feelings, whether right or wrong, are that if the capital gains are to be short term, then our basis should also be short term, not from 4 years ago.

Kenny

How do you determine the Value of a Life Estate?

All inherited property is long term.

gapdev said:

How do you determine the Value of a Life Estate?

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You use mortality tables, like insurance companies use.

But that is irrelevant in your situation since the old lady is dead.

all gains are considered long-term when property is inherited after a DEATH.

Ginny J said:

all gains are considered long-term when property is inherited after a DEATH.

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As opposed to when it's inherited before a death? Just had a flashback to one of my law school professors -- he always said, "A living person has no heirs. A living person has no heirs. A living person has no heirs." He really wanted us to get that down. Inheritance = somebody died; gift = they didn't. You betcha it was on the final!

Per, Reg. Section 1.1014-4(a)(2), the "uniform" basis of the property relates back to the time of the first death. The appropriate portion of adjusted uniform basis allocable to a particular interest in property is determined by accounting for changes in the relative values of the interests over time. This determination is made by using tables provided by the IRS to assign value to various interests in property for federal estate and gift tax purposes. Reg. Section 1.1014-5(a)(2). Based on certain actuarial assumptions, such as life expectancy and the current applicable federal mid-term rate of interest, these tables provide a "factor" that is then multiplied by the entire adjusted uniform basis to determine the amount assignable to the particular interest being sold.

So tranq, the basis would be the value of land subject to a life estate where full title would have been worth $375,000 + the value of the life estate finally inherited when full title would have been worth $525,000? That means if the evil stepmom died at 50, her life estate could have been fairly valuable, but if she was 92, it wasn't worth much at all? Or is the basis just something less than $375,000 with no "step up" for clearing the title of the life estate?


LdiJ --
I think I'd want to see your research, because it seems to conflict with my property law classes about how life estates work. Property is received when you have a right to dispose of it. It is perfectly legal to sell property that is subject to a life estate, you just won't get full market value for it because the buyer can't occupy the property until the LE owner dies or abandons the LE. It's like selling a house that has tenants with a lease -- the new owners get the tenants with the house & can't occupy until the lease expires or they bribe the tenants into leaving.

The situation you described would apply when there is an AB trust, common with married couples with stechildren. The trust is revocable until A dies, then becomes irrevocable. The surving spouse has a right to use the property until death, but can't encumber or sell it because title remains with the trust. Upon the second spouse's death, the trust conveys clear title to the heirs. Since the terms of the trust gave the heirs no rights to the property upon A's death, their basis is determined when B dies.


I suspect you & tranq are simply talking about two different estate planning strategies. In tranq's scenario, the heirs actually inherit title (a remainder interest in a fee simple subject to a life estate) upon A's death. The can sell the remainder interest at any time. When B dies, the life estate collapses & the remainder interest morphs into fee simple absolute. The calculation of basis will be . . . complex. In LdiJ's scenario, the beneficiaries receive nothing until B dies. They get to use the basis in effect when B dies. (Part of the reason trusts are common & life estates are scarcer than hen's teeth today.)

Mr. Kenny mentions both life estates and trusts, so I don't know which strategy was used. I can't think of any circumstances where a competant estate planner would use a life estate and a living trust. I suspect it was an AB trust & Mr. Kenny's just calling it a life estate because that is the generic term for how the trust functioned. On the other hand, it could be that the trust was supposed to pass title upon A's death & the trustee was just lazy. I'd need the actual trust documents (& a retainer) before I'd commit to either answer.