Calculating capital gains.

You’ll want to keep receipts to make sure keep your capital gains as low as possible.

Q: I read your recent article on capital gains and how to calculate them. Here’s my issue.

I thought I could shred a whole bunch of receipts accumulated during my ownership of my home. I see the feds are forcing people to sell within two years of a spouse’s death to get the $500,000 capital gains write off. So I’ll keep the receipts for the work we’ve done on our home.

Inheriting a home? Calculate capital gains carefully

My question is for any heir who inherits a home and decides to sell it. Would they get a capital gains write-off of $250,000 or $500,000, if any? Also, I thought I read it would be easier for the heir to sell the house if their name was put on the title prior to the death of their parents. When would the capital gain be calculated? When the parents bought the home? Or when the heir was added to the title to the home?

In either case the heir did not live in the home for five years preceding the sale.

Home sale exclusion shelters up to $500,000 in capital gains

A: Thanks for your question. Let’s start off by saying that the federal government isn’t forcing anyone to do anything with their real estate holdings. However, if you sell your primary residence and are expecting a large profit on that sale, the Internal Revenue Service (IRS) allows married couples to exclude up to $500,000 in profit from any federal income taxes. This exclusion is set up as $250,000 per person if the owners are not married or if only one person owns the home.

The most important requirement to qualify for this home sale exclusion is that you must have lived in the home as your primary residence for two out of the last five years. There are some other rules that go along with the exclusion, but that one is the most important.

Keep receipts to calculate capital gains 

If you’re planning to sell your home in the near future, and expect the profit to exceed $500,000 (if you’re married, or $250,000 if you’re single), you’re smart to keep receipts to prove what you paid to upgrade the property.

IRS Publication 523 explains how to calculate your cost basis. It also lists what you can (and can’t) include in calculating your profit. For example, let’s say you put on an addition to the home. What you spent on that addition increases what you put into the home. The IRS calls this your “basis.” But if you replaced lightbulbs, the IRS will consider that maintenance and won’t allow you to include that in your basis.

Once you know what you paid for your home, the costs that went into buying the home, what you put into the home, and the costs of selling the home, you’ll have a better idea of what your profit will be when you sell the home. If you are well below the $500,000 as a married couple, you won’t have to worry about paying federal taxes on the sale of the home. (Remember, if you are single or are the only owner of the home, your exclusion from federal taxes would be limited to $250,000.)

Heirs receive stepped-up basis; calculating capital gains changes

On a separate topic, when you die, your children will inherit the home at whatever the home’s value at the time of your death. Let’s say you purchased the home in 1970 for $100,000 and the home is now worth $1,000,000. And let’s further imagine that you didn’t improve the home over those years and sold it by owner. So, your only cost would be the $100,000 you paid for it.

If you sold today, we could say your profit would be $900,000, well above the $500,000 exclusion. However, if you and your spouse have both died, your kids would inherit the home at its stepped up value of $1,000,000.

If your heirs sell within a year, no need to calculate capital gains

If your kids then sell the home, your kids would have no federal taxes to pay on that sale. They inherited the home at a value of $1,000,000 and sold the home for $1,000,000 and had no profit.

That’s why we don’t think it’s wise to add children to the title of your home at this time. Your children will inherit the property at its current market value, also known as the stepped-up basis. You should talk to an estate planning attorney to make sure you fully understand this and to go over your options.

A better option might be to put the home into a living trust. That way, your kids automatically inherit your home upon the death of both you and your spouse. And, they’ll have no problem selling the home after you and your spouse have passed.

Living trust makes inheritance process easier; facilitates capital gain calculations

The trust document would name your children successor owners of your assets. Or you could designate that the successor trustee of your trust sell off the home upon your death. In either case, that successor trustee should have the power to dispose of your home simply by virtue of the terms you set up in the living trust.

With a living trust, you wouldn’t need to have your assets go through probate court. You won’t require any court’s approval to sell your home. Your trust, and the terms of the trust, should suffice to allow the person you designate in the trust to take care of your assets as you and your spouse wish.

©2023 by Ilyce Glink and Samuel J. Tamkin. Distributed by Tribune Content Agency.  C1610