What is the Surviving Spouses Taxable Gain on Sale of Home?

Category: Tax Law and Planning

A very common question is: If my spouse dies and I sell the house, what is my cost basis? Cost basis is important because Purchase Price - Basis = Gain (which is the Amount subject to Capital Gains Tax). The except below from This old house: cost-basis riddle -- Newsday.com is an excellent example of answers to that question.

However, cost basis is not the only issue. Once the Amount subject to Capital Gains Tax is determined, the next question is "What exclusions to Capital Gains Tax are there?" Under Internal Revenue Code Section 121, a single person can exempt the first $250,000 of Gain from the sale of his or her residence from tax (assuming the person has resided in the house for at least 2 years). This doubles to $500,000 for married couples.

So, if a surviving spouse is ever looking to sell the residence (no matter when the deceased spouse died) the questions are:

1 - What is the surviving spouse's Cost Basis in the house (see the examples below to calculate); and
2 - Is this Gain less then the Section 121 exemption available (if so, no tax).

"Imagine Fred and Ethel buy a house in 1982 for $135,000. In 2005, Fred dies and Ethel inherits the house, now worth $550,000. To calculate her profit when she sells it, she subtracts what the house cost - her 'cost basis' - from the $550,000 sale price. Current law says Fred and Ethel each had a 50 percent ownership stake in the house. Her cost basis on her own half is $67,500 - half of the original $135,000 purchase price. But her cost basis on Fred's half is its market value at the time of his death - $275,000 (half of $550,000). Her total cost basis: $342,500.

But before 1977, the law presumed that the spouse who died first owned 100 percent of the house, says Alan E. Weiner, senior tax partner at Holtz Rubenstein Reminick in Melville. Unless the surviving spouse could refute the presumption, the house was included in the deceased spouse's estate and the survivor inherited it at its market value. (The husband, usually the first to die, was also usually the only working spouse. 'It's unclear how the law would work if the first to die was a wife who hadn't contributed to the purchase of the house,' Weiner notes.)

Let's say Fred and Ethel bought their house in 1960 for $17,000. When Fred died in 2005, it was worth $450,000. Under the pre-1977 law, the entire $450,000 is included in his estate. No additional estate tax is due, however, because spouses inherit from each other tax-free. Ethel has inherited 100 percent of the house; her cost basis is $450,000.

The IRS says the old law still applies in cases involving marital joint property acquired before Jan. 1, 1977. It has said it will no longer litigate such cases. (For more details, go to www.irs.gov/pub/ir"