Understanding 'stepped-down' tax basis for real estate

If value has dropped, gifting property before death may be smart tax move

By Inman News Feed
Add Comment Add Comment | Comments: 0 | Posted May. 30, 2012

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If value has dropped, gifting property before death may be smart tax move

Benny Kass
Inman News®

DEAR BENNY: You frequently write about the stepped-up basis when a property is inherited. In today's market, however, you may find the reverse situation.

For example, let's say I purchased a house for $600,000 several years ago, but the current value is $400,000. If my children inherit the house, can they keep the $600,000 basis or do they have to lower the basis to the new present market value of $400,000? If they sell the house for $400,000, can my children divide up this $200,000 loss and use it on their individual tax returns? --Art

DEAR ART: Yours is an interesting question, and clearly timely in light of many properties that have lost their value over the past few years.

It is my opinion that the tax basis of the property in the hands of your children is still the value of the property on the date of death, even if it is less than the decedent's basis in the property. (It should be noted that the IRS permits an alternate valuation after death; namely, you can elect to look at the value six months after the date of death). In other words, your children will get a "stepped-down" basis.

So, contrary to what I have been writing about not transferring property to your children before you die (so they can take advantage of the stepped-up basis), it may make sense for elderly individuals who have a high tax basis to transfer the property to their children while they are still alive. Why? Because the basis of the giftor becomes the basis of the giftee.

If the person dies, the heirs will get only the value of the property on the date of death. Talk to your financial advisers about this issue; there are many complex issues involved.

If your children sell the property for $400,000, which was the value on the date of death, they have made no profit. Thus, they cannot take a loss, if this was not investment property. If it was held for investment, i.e., rental, you need to get professional tax assistance.

DEAR BENNY: How can a condo association terminate an owner's right of possession for being behind in assessment fees? The association never met with me to find out if I was in a hardship situation. Not only that, but how can the association allow others to pay on a payment plan and not permit me to do that?

Unfortunately, this association has its favorite individuals that it treats better than others.

I received a letter from the law office to immediately pay in full or terminate the premises. --Gerald

DEAR GERALD: The first thing you should do is retain an attorney to represent you. I recognize this costs money, but your condo -- your investment -- is at stake, and unless you are prepared to lose it, you need legal assistance.

Community association law throughout the country is quite clear: An association cannot discriminate and show favoritism to one owner without providing that same benefit to all owners. Selective enforcement is prohibited.

As to whether you can be "tossed out" of your condominium, you first have to review the legal documents of the association. However, we still have a concept of "due process" here in America despite what many critics claim. That means that before you can be removed from the condo, you have the right to go to court to challenge the association's actions. And, if you are right that they are not treating you the same as they treat others, that should be a good defense.

But, you really should retain a lawyer to assist you.

DEAR BENNY: My father-in-law died last March. He bought property in the 1990s for about $250,000 and put it in a limited liability company (LLC). It just sold for $965,000, but $550,000 went to paying off an existing mortgage. Will the LLC have to pay capital gains tax on the whole $965,000 or on the money left after paying the mortgage off? --Tim

DEAR TIM: You must discuss the situation with an accountant who will help you prepare the tax return for the LLC. Keep in mind that a limited liability company does not pay any income tax; it merely files an annual information tax return. Any profits or losses are passed on to the members of the LLC by way of Schedule K-1.

Oversimplified, whether it is owned by an individual or an LLC, a profit or loss is determined by the difference between the basis and the sales price. The basis, in your situation, is the purchase price of $250,000. But don't forget to review the settlement statement (now called a HUD-1) because basis also includes the settlement or closing costs you paid in order to get the loan and the property. These could include title search, survey charges, title insurance costs, and recording fees.

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