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Question:

My son-in-law’s grandparents died in 2015 and 2016. His mother inherited their home after the estate was probated in Maryland. The deed was transferred to her name in 2017 and my son-in-law just found out that at the same time she gifted a half interest to him and added him on the deed as joint owner with right of survivorship. He is concerned that she may have gotten some bad advice since the home value in 2016 was approximately $450,000 and it is now in 2023 approximately $700,000.

Is it correct that when his mother dies that his cost basis for his half will be $225,000 (1/2 of $450,000) while he will receive a step-up in basis for the other half? Then when he goes to sell the house will he owe capital gains taxes on his half since he didn’t get a step-up in basis on his half or does he get a stepped-up basis on the entire house? I did some research on my own and based on this statute, 26 U.S. Code § 2040 – Joint interests, and this article, “IRS Issues New Basis Consistency Regulations,” it seems that the recipient of an JTWROS by gift (with no personal investment) and who is not a spouse, qualifies for a fully stepped-up basis. I know that having the house owned as JTWROS can present other problems but it appears paying capital gains on his half isn’t one. Is this, correct? Wouldn’t she have to file a gift tax return since she gifted half interest in the house?

Response:

The statute you reference is very hard to decipher. But my understanding is that this comes down to is your son-in-law’s mother’s intent in adding her son to the deed. Was she intending to give him an ownership interest in the property or adding his name as a substitute for a will or trust, intending that he only take ownership upon her death? If the mother did not file a gift tax return (and it sounds like she did not) and acted as the sole owner of the property (which seems to have been the case), then there’s a strong argument that upon her death the entire property should be in her estate and receive a complete step-up in basis.

But to be safe, they should transfer the house back into her name and then perhaps put it into a revocable trust which would also avoid probate and eliminate any uncertainty regarding capital gains. Another approach would be for your son-in-law’s mother to write her son a letter explaining what she had in mind when she added his name to the deed (assuming it was not to give him one-half ownership). This could help if your son-in-law’s tax return is audited once he sells the house, but it could also be seen as a bit self-serving. I’d start by asking her what she had in mind in adding your son-in-law to the deed without any coaching beforehand, and then go with the results. If it was for estate planning purposes only, then have her write the letter. If it was intended as a gift, transfer it into a revocable trust with your son-in-law’s mother as grantor. They could both be co-trustees.

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Does Step-Up in Basis at Death of Joint Owner Apply Only to Her Half of Real Estate? Will House Deeded to Spouse Just Prior to Death Receive Step-up in Basis? Will Property in an Irrevocable Trust with a Power of Appointment Receive a Step-Up in Basis?