Question: I'm 94 years of age and own a home in Massachusetts. When I pass, will my heirs be able to take the $250,000 federal capital gains deduction that I would have been entitled to if I sold the house? Does this differ from state to state?
Response: No, you cannot pass on your $250,000 capital gains exclusion to your heirs, but they won't need it because they get something better – a step-up in basis.
To explain, capital gains are calculated as the difference between the proceeds on the sale of property and the property’s tax basis. The tax basis starts as the purchase price of the property, but it can be adjusted in a few ways. One is that you can add in the cost of improvements to the property. For instance, if you purchased the property for $100,000 many decades and subsequently remodeled the kitchen at a cost of $50,000, the new basis would be $150,000.
However, what's more important in your situation is that the basis gets adjusted upon the death of the owner to the property's date-of-death value. So, if your home had a market value of $1 million upon your death (house prices are high in Massachusetts), that would become the new basis. This is often referred to as a "step-up" in basis or "stepped-up" basis. If your heirs then sold the property for $1 million there would be no capital gain and no tax due.
And since this has to do with the federal tax on capital gains, it applies in all states. In addition, all states that have their own tax on capital gains also accept the step-up in basis.
Be aware that some argue that the step-up in basis should be eliminated especially since very few estates now pay estate taxes. The federal threshold for taxation is now just under $14 million and most states have eliminated their estate and inheritance taxes. When the federal threshold was lower and more states taxed estates, taxing capital gains on inherited property seemed like double taxation. Now, some argue that heirs escape any taxation and that helps the wealthy stay wealthy to the detriment of everyone else.
Without wading into the political debate, as an estate planner I like the step-up in basis because it greatly simplifies bookkeeping and it provides an incentive for seniors to retain their assets and thus their independence and dignity.
Harry S. Margolis practices elder law, estate and special needs planning at Margolis Bloom & D’Agostino in Wellesley, Massachusetts, and a Fellow of FreeWill.com. He is author of The Baby Boomers Guide to Trusts: Your All-Purpose Estate Planning Tool and answers consumer questions about estate planning issues at www.AskHarry.info. Please post your estate planning questions there.
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