Dear Harry,
My spouse passed away this year. Prior to his passing, we sold our second home (not our primary residence). We understand there will be capital-gains tax to pay. However, do we get a one-half step-up in basis due to my spouse passing away in the same tax year we sold the property even if he passed away after the sale of the home?
Dear reader,
Unfortunately, the answer is no. As you appear to know, normally when you sell property you must pay a tax on the capital gain, which is the difference between the sale proceeds and the property’s tax basis. The basis is what you paid for the property plus the cost of any improvements.
If the property were your home, you and your husband could exclude the first $500,000 of gain, $250,000 each. But this exception only applies to your personal residence.
When the owner of property dies, the basis gets adjusted to the value on the date of death. When the co-owner dies, there’s a one-half adjustment. So, by way of example, if you and your spouse purchased the property for $200,000 and it had a fair market value of $500,000 when they died, the basis would have been adjusted, or “stepped-up,” to $350,000. This reflects the fact that your original one-half share would still have a $100,000 basis while the other half that you inherited from your spouse was stepped up to $250,000.
Unfortunately, your spouse still would have had to have been the co-owner on their date of death for this adjustment to have happened. Since he no longer was, even though he died within the same tax year as the sale, the property did not receive a step-up in basis. So, again using our example, if the property had been sold for $500,000 the taxable gain would have been $300,000 rather than the $150,000 it would have been with the step-up.
Where this can get confusing is that the spouse’s share of the $500,000 capital gains exclusion on the sale of a personal residence does survive death, at least for a while. If the property were your personal residence, you could still exclude the full $500,000 of capital gain if you sold the property within two years following his death. After that, you would only be able to exclude your own $250,000 of gain.