Knowing the cost basis of your property is important for tax purposes, but proving cost basis can be difficult. Cost basis adjusts at death, so it is always a good idea to appraise your property when a joint owner dies.
Posted on November 6, 2023
What is Cost Basis?
Cost basis is the monetary value of an item for tax purposes. To calculate how much you owe in capital gains tax on property, you use the basis to determine whether an asset has increased or decreased in value.
For example, if you purchase a house for $150,000, that is the cost basis. If you then make improvements to the property, you may be able to increase the home’s cost basis.
Suppose that you make no improvements, and you later sell the house for $250,000. You will have to pay taxes on the $100,000 increase in value. (However, if the property is your principal residence, you can exclude up to $250,000 in capital gains, or up to $500,000 for a couple.)
What Happens to Cost Basis When a Property Owner Dies?
When a property owner dies, the cost basis of the property is "stepped up." This means the current value of the property becomes the basis.
For example, imagine you inherit a house that a family member had purchased years ago for $50,000. The home has increased in value over time, and when the family member who owned the property dies, the home is worth $250,000. You will therefore receive a step up from the original cost basis – from $50,000 to $250,000. If you sell the property right away, you will not owe any capital gains taxes.
When a joint owner dies, half of the value of the property is stepped up. For example, suppose a couple buys property for $200,000, and then the husband dies when the property has a fair market value of $300,000. The new basis of the property for the wife will be $250,000. That is, $100,000 (for the wife’s original 50 percent interest) plus $150,000 (for the other half passed to her at her husband’s death) = $250,000.
There are other scenarios that can affect a property’s cost basis as well as any capital gains taxes you may owe.
For example, your home may have decreased in value over time for some reason. This could have an impact on the cost basis.
Perhaps you are considering gifting a piece of property to your children. Should you transfer the home to your kids during your lifetime, or let them inherit it after you have died? How would this affect the cost basis? Also, what would the tax implications be of each option?
Either way, connect with an experienced estate planner to understand the best options for your unique circumstances. Professionals with expertise in this area can also assist you in creating a plan that avoids negative tax consequences where possible.
Proving Your Cost Basis
The burden is on the property owner to prove the cost basis. It isn't always easy to do, especially if a considerable amount of time has passed since the owner purchased the property or made improvements to it. Homeowners should keep good records of improvements they have made to a house, including keeping copies of all receipts and purchase orders.
If a joint owner of property dies, you should get the property appraised to show the value at the time it is stepped up in basis. Be sure to save the documentation so you can use it later.
Again, a qualified estate planner can guide you on what your best options are in these situations. Search for an estate planning attorney near you today.