How Do We Determine the Cost Basis on Inherited Real Estate?
If a property appraisal was never obtained when a parent died in 2013, how can we determine the cost basis when the four siblings who inherited the home sell it?
As you know, when you sell real estate you have to pay a tax on the capital gain, which is the difference between the sale proceeds (after the brokerage commission) and the basis. Typically, the basis is the purchase price of the property plus any improvements (maintenance costs don’t count). So, for instance, if you purchased a house for $200,000 and spent $50,000 updating the kitchen, the basis would be $250,000. If you then netted $500,000 on the sale, your capital gain would be $250,000. Fortunately, if it’s your home, you don’t have to pay taxes on the first $250,000 of gain (and if you’re married you can exclude $500,000 of gain).
All of this changes when the homeowner dies. At death, the basis gets adjusted, or “stepped up,” to the value on the date of death. In our example, if the house was worth $500,000 on the date of death of the homeowner, its basis would then be $500,000. If the value then increased to $600,000 since 2013, the capital gain on its sale would be $100,000, a much better result than the $350,000 of gain if the basis had remained at $250,000. This is especially true, since you can’t exclude any of the gain if you don’t live in the house.
But how do you determine the fair market value as of the date of death? It’s easy if you’re selling the property soon after the homeowner’s death, since putting the house on the market is the best way to determine its fair market value. However, this won’t work if several years have passed since the inheritance. In that instance, the best method to determine basis is to get a qualified appraisal. An appraiser can determine the fair market value for any date you choose. You might also use the tax assessment, but those are often low, which would mean a higher capital gain for you and your siblings when you sell the property. A third alternative would be a written statement from your realtor. While this would not have the weight with the IRS of an official appraisal or tax assessment, it would probably pass muster if done in good faith. This means that if it were challenged, you might have to pay interest on any unpaid tax, but no penalties. Given that risk, the safest bet is to get a qualified appraisal.