Q: In 1975, my parents built a four bedroom house on Cape Cod and they put my name on the deed with theirs. My parents died quite some time ago, so I have had the house since then.
For most of those years, I lived in Syracuse and would stay at the house each summer for a short visit. I’ve lived in Sarasota, Florida now for almost 20 years. My husband passed away about a year ago, and I’m wondering what I should do about the house.
The home is in a real estate trust and our surviving five children will inherit it. But, I’m considering selling it. I am afraid my capital gains tax will be astronomical because the home cost around $50,000 when they bought it and now it’s worth about $500,000! We have made many improvements to the home over the years including a new roof, back, furnace, gutters, just to name a few.
My children are not well off and none could afford to buy out the others. Any ideas on what I should do?
A: We’re sorry for your loss last year. It’s clear that over the years, you have quite a bit of money invested into the Cape Cod home. While you might think that you’d have to pay taxes on the difference between the purchase price of the home and what the home is now worth, that’s not exactly how it works.
If you sold your home today, you would have costs related to selling the home. You also have considerable capital improvements that you’ve made to the home over the years. These would all push up the cost basis of the home and ultimately reduce your taxes.
Here’s how it might work. Let’s assume that you put about $100,000 in capital improvements over the years and you have about $50,000 in expenses when you sell the home. If you sold today, you’d have to pay tax on the difference between the sales price of the home, less the costs of sale and capital improvements, then subtracting what you paid for the home and any costs associated with the purchase (if you can remember them).
In this example, we’d say that your profit on the sale would be about $300,000 rather than $450,000. That’s quite a nice sum of money, particularly if you don’t have to pay off a lender when you sell the home.
If you were to sell before the end of 2012 and used today’s maximum capital gains rate of 15 percent, you’d end up paying about $45,000 in federal income taxes.
If you sell in 2013, your tax bill will rise. If capital gains taxes go up to 20 percent, you would pay about $60,000 in capital gains tax. But you would also be subject to the new Medicare tax of 3.8 percent on any income above $200,000 as a single person. That would add another $3,800 of tax (for the first $100,000), and you’d pay that extra 3.8 percent on any amount of income over the limit. So if your income for the year was $400,000, you’d pay an extra 3.8 percent Medicare tax on $200,000, or $7,600.
But even with that extra tax, you’d only pay a total of $63,800 in tax on roughly $475,000 in cash (after paying a 5 percent commission). You’d walk away with $411,200. That’s a nice chunk of change and you could then make cash gifts to your children of $13,000 each tax free to give them a helping hand now, rather than letting them inherit all of it. Then you get to enjoy helping make their lives easier.
There’s a secondary benefit to cashing out now and giving away the money and that is we don’t know what is going to happen to the inheritance tax. If it falls to $1 million, your estate might wind up giving up a chunk to federal estate tax, which would be unfortunate.
Let’s think about what happens if you don’t sell. You and your family could continue to use it and at some point, when they become owners of the home, they could sell the home. If this is your only asset or your whole estate is not that large and less than $1 million at the time of your death, you won’t have to worry about you, your estate or your kids having to pay any estate taxes. If the estate tax laws roll back in time, you’ll still have the ability to exclude from federal estate taxes up to one million dollars. If the estate laws change and they come up with a higher number for you, it may not impact you anyway if your estate will be less than $1 million when you die.
One aspect of estate law that’s yet to be determined is whether the “stepped-up” basis rule stays or goes. If the stepped-up basis rules exists in the year you die, your kids will inherit the property based on the value of the Cape Cod home at the time of your death. If this rule exists at that time, your estate wouldn’t have any federal estate taxes to pay and your kids could sell the home and they wouldn’t have any federal income taxes to pay. They wouldn’t even have any capital gains taxes to pay.
But if the stepped-up basis rule goes away, when your kids sell the home after your death, they would pay taxes when they sold the home.
With so much up in the air, and so much cash at stake, you should hire an estate planner or accountant to review your whole estate and see if you are better off doing something now or later and minimizing the impact that estate taxes, capital gains taxes and other taxes may have on you and your family in the years to come.