Do You Pay Capital Gains Taxes on Property You Inherit?
Medicaid and Nursing Home Asset Protection Planning often coincides with very important tax considerations. You have to look at these tax issues before setting and Elder Law plan into motion. This is not to say that the tax implications will rule the decision making, but you need to be aware of what the implications will be. Also, there may be a solution that you can take advantage of that will serve to both protect assets AND get a good tax result.
Tax Basis Issue: When you inherit an asset, such as a house or stock or mutual fund, the asset is frequently worth more than it was when the original owner purchased it. If the decedent had sold the asset during his or her lifetime, there could have been a significant capital gains tax. Fortunately, when you inherit an appreciated asset, the asset’s tax basis is “stepped up,” which means the basis would be the value of the asset as of the date of death of the owner.
For example, suppose you inherit a house that was purchased years ago for $150,000 and it is worth $350,000 on the date of death. You will receive a step up from the original cost basis of $150,000 to the date of death value, $350,000. If you sell the property immediately after the date of death, you will not owe any capital gains tax. If you hold onto the property and sell it for $400,000 in a few years, you will owe capital gains tax on $50,000 (the difference between the sale value and the stepped-up basis). This step up in basis can serve to provide a significant tax savings.
On the other hand, if you were given the same property, as opposed to receiving it upon the owner’s death, the tax basis would be $150,000. There is no step up in basis for gifts made during the owner’s lifetime. If you sold the house, you would have to pay capital gains tax on the difference between $150,000 and the selling price. One way to avoid or reduce the tax is for you to live in the house for at least two years before selling it. In that case, you can exclude up to $250,000 ($500,000 for a couple) of your capital gain on the property.
Determining the Stepped Basis: It is important for you to document the value of the inherited asset as of the owner’s date of death. It is possible that the IRS will ask for evidence of the date of death value when determining the basis of the asset. For real estate, we suggest obtaining a certified appraisal or if the property is sold shortly after the date of death, the settlement sheet from the sale should suffice. For stocks and mutual funds, you should obtain a date of death valuation letter from the broker or advisor handling the asset. Keep these documents as a means to substantiate the step up in basis to the IRS when the time comes to do so.
The asset basis issue is an important and potentially confusing one to consider when making gifts to protect assets from nursing home expense. It is very important that you have professional guidance BEFORE making any gifts of assets. We know that the prospects of losing assets to long term care costs can be scary and that time is often of the essence. However, it is possible to get the best of both worlds, asset protection and step-up in basis. You just need the right planning and guidance.
For more information regarding this complex tax basis issue and Elder Law and Estate Planning in Pennsylvania, please contact Douglas L. Kaune, esquire at 610 933 8069 or email him at dkaune@utbf.com. Unruh, Turner, Burke & Frees, P.C. is a full service law firm which has three convenient office locations in Phoenixville, West Chester and Paoli, Pennsylvania. The firm primarily services clients in Chester, Montgomery, Delaware, Philadelphia, Bucks and Berks Counties, but can represent clients throughout Pennsylvania.
