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Question:

I am  the successor trustee for my grandma who lives in Arizona. She has a home in California in her trust. I’m planning on selling the house when it’s time. My question is will I have to pay capital gains tax or the step-up tax?

Response:

To clarify, the “step-up” is not a tax. Instead it is a feature of the capital gains tax system that relieves those inheriting property from having capital gains. Here’s how it works:

Capital gain is calculated as the difference between the proceeds of sale and the basis in property. The basis begins as the property’s purchase price. So, if you bought property for $200,000, that would be the basis. If you then sold it for $500,000 you would have gain of $300,000.

However, when the owner of property dies, the basis gets adjusted or “stepped up” to the value on the date of death. So if that were $500,000 in our example, that would be the new basis. If you then sell the property for $500,000, there’s no gain and, consequently, no tax. If, on the other hand, you waited to sell the property until its value increased to $600,000, you would have taxable gain of $100,000.

In your case, your grandmother is still alive, so her California property has not received a step-up in basis. Further, since she lives in Arizona, not in the California property, she is not eligible for the $250,000 exclusion of capital gain on the sale of her home. The one adjustment she might be eligible for involves improvements to the property. Their cost may be added to the basis. So, using our example again, if your grandmother had spent $100,000 updating the kitchen or adding a garage, the basis would be $300,000 instead of $200,000, reducing the gain and the tax. She just has to have records of the expenses and they must be for improvements, not maintenance. For instance, painting the house doesn’t qualify, but putting up new siding does.

But, finally, I see your reference to “when it’s time.” If by that you mean when your grandmother passes away, then the answer is that the house will receive a step-up in basis. Your grandmother doesn’t have to be living in the property for its basis to be adjusted upon her death.

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