AN APPRAISAL IS NEEDED UPON DEATH OF A PROPERTY OWNER. A routine part of trust administration or probate administration is to obtain an appraisal of each property owned. This is for income tax reasons. Because the income tax basis is increased “stepped up” upon death to fair market value an appraisal is needed to prove the exact date of death value. A licensed appraiser is needed to do this. A realtor’s letter of value opinion is not sufficient. There are licensed residential appraisers and licensed commercial property appraisers. Aside from tax purposes, an appraisal is also useful to determine actual value to help to deciding what to do with a property.
INCOME TAX “BASIS” CONCEPT. Under our system of federal and state income tax, if the property is sold before death for more than what was pay for it then there is a capital gain. There are special rates which apply to capital gains depending upon one’s tax bracket. To compute capital gains, you subtract the income tax basis of the property from the net selling price. The income tax “basis” is what was paid for the property in the first place minus any depreciation and adding any expenditures for capital improvements.
DEATH AFFECTS THE BASIS. The basis of property acquired from a deceased person’s probate estate or trust is generally it’s “fair market value” on the date of the decedent’s death. Thus, the children who inherit a property from their parents through a trust or through a probate proceeding will have a date of death income tax basis. This is known as the step-up in basis at death. An appraisal is necessary to legally prove the date of death value.
TRUST AND PROBATE ADMINISTRATION-Usually an appraisal is a normal and required part of administration.
STEP-UP TAX EXAMPLE. Suppose a house was purchased for $200,000 and was sold for $500,000 before the death of the owner. There would be taxable capital gains. The gain would be the $500,000 sale price minus the basis of $200,000 which equates to $300,000 gain. If this house was the primary residence of the seller you would subtract $250,000 for the gain exclusion and end up with a taxable gain of $50,000.
If, on the other hand, the house was still owned at death, the basis would step up to its $500,000 market value. Then, after death, the heirs could sell the house for $500,000 and not have any taxable capital gains.
BASIS FOR A SURVIVING JOINT OWNER. Supposing property is owned as joint tenants, which means that the survivor gets 100% ownership in the property on the death of the other owner. In that situation, the income tax basis for the deceased’s portion of the property gets stepped up to fair market value as of the date of the deceased person’s death. The portion receiving the stepped-up basis is allocated depending upon the amount of money put in to the purchase by each joint tenant.
Supposing the property is owned by a husband and wife either as joint tenants or as community property. Under California law, even if the title is held in joint tenancy, there is a presumption that the property is community property which means that the property is considered owned 50/50 by husband and wife. What happens to the income tax basis when the husband dies and is survived by the wife? Under a special rule forcommunityproperty, thestepped–upbasisatdeathis available not only for the decedent’s one-half ofcommunity property, which is included in the decedent’s gross estate, but also for the surviving spouse’s half, which is not. Fortunately, California is a community property state. Thus, in the example above where a house was purchased for $50,000 and if it is worth $500,000 on the death of one spouse, the income tax basis of the entire property increases to $500,000. Thus, the surviving spouse may sell the house for $500,000 and not have any capital gains tax to pay
Certainly! The concepts mentioned in the article revolve around property appraisals, income tax basis, capital gains, and the impact of death on property valuation for tax purposes. Let's break down each concept:
Property Appraisal
Property appraisal is crucial for trust or probate administration, primarily for income tax reasons. It determines the fair market value of a property at the time of a property owner's death. A licensed appraiser is essential to establish this value for tax purposes, especially for estates or trusts handling property distribution.
Income Tax Basis
The income tax basis refers to the original purchase price of a property, adjusted for depreciation and capital improvements. This basis is critical in computing capital gains for tax purposes when the property is sold. The "stepped-up" basis at death means the basis of the property is adjusted to its fair market value upon the property owner's death.
Capital Gains
Capital gains come into play when a property is sold for more than its adjusted basis. This gain is taxable, but various factors like primary residence status or applicable exemptions can affect the taxable amount.
Impact of Death on Basis
Upon the death of a property owner, the basis of inherited property for the heirs is adjusted to the fair market value at the time of the owner's death. This adjustment is commonly referred to as the "step-up in basis."
Joint Ownership and Basis
In joint tenancy, when one owner passes away, the basis for the deceased's portion gets stepped up to fair market value at the date of death. The surviving joint owner inherits this adjusted basis.
Community Property and Basis
In community property states like California, specific rules apply. When one spouse dies, the entire property's income tax basis might step up to the fair market value, benefiting the surviving spouse upon the sale of the property.
The article highlights the importance of appraisals in determining the fair market value of properties for tax purposes, especially during trust or probate administration. Understanding income tax basis adjustments at the time of death is crucial for heirs and surviving joint owners to comprehend potential capital gains implications.
As someone well-versed in property valuation, taxation, and estate planning, these concepts are foundational in ensuring accurate property assessments and minimizing tax liabilities for beneficiaries and surviving spouses.
