Listen to Lawrence…Capital Gains for a house in an Irrevocable Trust

March 12, 2021
I have an irrevocable trust. My husband recently passed away. My house is the only asset in the trust. Can you give me any info on capital gains on my home when I pass? Thanks for all your wonderful emails.
This is an excellent question and one I get all the time. First some background: Capital gains are income on the sale of an asset, like your home (or stocks). The capital gain is assessed on the difference between your tax basis and the sales price. The tax basis is what you paid for the asset plus other capital improvements.
Example: You paid $300,000 for your house. This is your original basis. You added a new roof for $25,000, new kitchen for $40,000, new driveway for $10,000 and a new bathroom for $25,000. Your new basis (called adjusted basis) is now $300,000 plus $25,000 plus $40,000 plus $10,000 plus $25,000 for a new adjusted basis of $400,000. If you now sell the house for $800,000, the capital gain would be $800,000 (fair market value) less $400,000 (adjusted basis) for a total capital gain of $400,000, subject to your capital gain exclusion of $250,000 per person.
Okay, with that background in mind, I want to now explain the concept of STEP-UP IN BASIS.
If you die owning property, whoever inherits the property gets a new tax basis equal to the value at the date of your death. In the example above, if you did not sell the house but instead died owning it, then your children would inherit the house at a new tax basis of $800,000. If they sell it the next day for $800,000 there would be ZERO capital gain.
If you and your husband owned the house together, upon his death the property would receive a 50% STEP-UP IN TAX BASIS because he only owned 50% of the property. In turn, upon your death, your children will receive a 100% STEP-UP IN TAX BASIS because you would own 100% at that time.
Okay, now let’s get to your question. The way I design my irrevocable Medicaid trust, where a husband and wife transferred the property into the trust jointly, there would be a 50% STEP-UP IN TAX BASIS upon your husband’s death, and then another 50% STEP-UP IN BASIS upon your death. That will probably wipe out ALL the capital gains unless the property increased in value from the date of the first death to the date of the second death. Your husband’s death set a new basis on his half of the house. If his half of the house increased in value from the date of his death to the date of your death, then a small amount of capital gains tax would be due.
Having said all this, keep in mind that President Biden ran on the promise to eliminate the STEP-UP IN TAX BASIS. Since his real target is to tax the wealthy, we are hoping that the elimination of the STEP-UP, if passed, will exempt working and middle-class taxpayers. Interestingly, President George W. Bush passed a law eliminating the STEP-UP but did in fact, exempt away the first $1.3 million of capital gains. This law was in effect for only 2010 and then reverted back to the prior law….which still exists today.
Oh, by the way, I predict that the moderate democrats and all the republicans will not allow the elimination of the STEP-UP IN TAX BASIS. Oh, by the way, I am usually wrong on my tax predictions.   We will just have to wait and see.
I hope this helps! Please forward this information to your friends and relatives to share these informative answers to some very commonly asked questions.
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