What is Tax Liability on Sale of House Inherited Through Life Estate?
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Question:
What is the tax liability be on the sale of a house that was inherited through a life estate? Synopsis: life estate deed signed on 2021; life tenant passed away in 2023; prepared house for sale 2023-2024; sold house in 2024; life tenant was the sole resident of house.
Response:
Little or none. The house received a step-up in basis upon the life tenant’s death. To explain, the tax on the sale of property, whether real estate, stock, or artwork, is the difference between its basis and the sale proceeds. The basis starts as the property’s purchase price. But when the owner dies, it gets adjusted, or “stepped up,” to its fair market value on the date of death. This generally eliminates the capital again and, as a result, any tax on its sale.
This applies to life estates as well as to property wholly owned by the decedent. So, in your case, the only taxable capital gain would be any increase in the value of the home between their death in 2023 and the sale of the house in 2024. Presumably any increase in value would have been offset by the real estate broker’s fee or improvements you may have made to the house to prepare it for sale. The cost of actual improvements may be added to the basis. Deferred maintenance expenses may not be.
(One caveat: the step-up in basis for life estates only applies to those for which the creator of the life estate was also the life tenant. If, on the other hand, someone else created a life estate for the decedent, whether as a gift or part of an estate plan, it would not receive a step-up upon the life tenant’s death.)
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