You no longer must buy another home in order to claim the capital-gains exemption. An earlier version of this article incorrectly said you had to.
Dear Ms. MoneyPeace:
My first wife died in 2013 and I remarried in 2014. My will gives my wife my house. I have owned four houses in four states starting in 1964. Each appreciated in value. I have not paid any capital gains tax as yet. When my wife sells after my death, how will her cost basis be determined?
My will and my house are in San Diego.
Capital-gains-less so far
Congratulations on selling homes that have gone up in value. The real-estate market has treated you well.
You bring up several issues in this one question. The answer, in part, comes down to whose name is on the deed currently. In addition, you may want to take some actions to save you money on capital gains in the future, no matter who owns the home.
The deed on your current home may be only in your name, or joint with your wife. If the house is only in your name and she receives it at your death, the IRS considers her full ownership interest to be the value on your date of death. This is known as the step-up basis.
If she currently owns half of the home, then she will get a step-up value on the 50% she inherits at your death. The remaining 50% is the value on the house when it was acquired by you, assuming you bought the house and brought it into the marriage.
Most states are common-law states. If the title or deed to the property is in both names, each owns one-half interest. If the property is in joint tenancy with the right of survivorship, the property goes to the surviving spouse regardless of what the will says.
But marital property in community-property states like California is owned by both spouses equally. From your letter, it sounds like this home was acquired before the marriage. You may have made special provisions to keep it as separate property, or the home may have become co-mingled property and owned by both of you.
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A general note on inheritance: All property gets a step-up in cost basis to the current value for the new owner following a death. This goes beyond your home to monies in a brokerage account and other assets. If others inherit your property, they will receive the step-up in value, whether they are relatives or friends.
How capital-gains taxes on a home work
Capital-gains taxes occur when you sell your home. They are paid to both the state and federal government. The fact you have not paid capital gains taxes to date is based on the laws in place when you sold your homes. You don’t need to worry about being taxed on those capital gains now, only on your current home sale.
If you were to sell now and you were the sole owner, you would be responsible for the capital taxes, less a tax-free exemption of $250,000. However, if you and your wife own the home the capital-gains tax would be based on the sale price less a $500,000 tax exemption as a couple. These exemptions apply as long as you have lived in the home two out of the past five years and has not been taken in the last five years by either one of you.
As you plan ahead, understand that taxes on capital gains were lowered in 2017 and remain the lowest in decades as of this writing. In 2021, single filers with an income over $40,400 pay a 15% federal tax on long-term capital gains and a 20% federal tax if their income is over $445,850.
A married couple filing jointly pays 15% on long-term capital gains with income between $80,800 and $501,600, and 20% with greater income. Those whose incomes are less than $40,400 as a single filer or $80,800 as a married couple filing jointly do not pay federal tax on pay nothing in federal income taxes on capital gains.
If you are unclear about your situation, talk to a tax pro.
Tally the money spent on home improvements
Home prices have skyrocketed, and many have put off selling because they fear their capital gains will be over the exemption amount. If you are delaying selling a too-big home because of the gain and the fear of taxes, there is something you can do now to prepare.
Whether because of downsizing, the death of a spouse or a forced sale due to illness, you can increase the home’s cost basis for tax purposes by calculating the cost of any improvements you have made on the property. Think new kitchen, bath or outdoor patios and lights – essentially anything beyond paint and maintenance. Here’s the full IRS list of what qualifies.
Save yourself stress and taxes in the future by keeping a tally of these costs. Find that paperwork now so you can keep those receipts and information filed separately.
When the house is sold, provide these numbers to your accountant. These will increase your basis and will save you paying unnecessary capital-gains taxes.
Caution: Do not increase the cost basis of your home by making improvements you do not need or want. There is no guarantee that expense will be offset by the selling price, no matter what your real estate agent says.
Check your estate-planning documents
In addition, review your will. Your will is written in California, though you do not say if it was written before or after your 2014 wedding. California law, your will and your beneficiary designations need to be followed despite whatever your intentions are. Your will and estate-planning documents should be updated to reflect your current marriage and account for any children either of you may have. Your wife should do the same.
“As with any milestone, marriage is a time to revisit your prior estate plan,” says lawyer Amy Menard, principal at Putnam and Menard, in Middlebury, Vermont. “Be sure the document reflects current circumstances and goals.”
Having a lawyer you each trust is especially critical in California, where any estate worth at least $150,000 is required be handled in probate court. You or your wife will want a trusted advisor to help you with this filing. There are titling changes a lawyer may recommend, such as “community property with right of survivorship” that would allow the property to pass without waiting for the probate court proceedings.
Finally, you assume that you will die before your wife. Though I am sure you have reasons for making this statement, good estate planning also accounts for the alternative. On the off chance that she was to die first, you want to be sure her will and estate documents are up to date.
CD Moriarty is a Certified Financial Planner, a columnist for MarketWatch and a personal-finance speaker. She blogs at MoneyPeace.