Can I get full capital gains exclusion on my house?

by G. Scott Haislet, CPA, Esq.

My wife recently died, and I’m wondering if there is some way I can get the full $500,000 capital gains exclusion on the sale of our house.

If you and your wife owned the property as your community property or your wife owned the property solely (as her separate property), then the income tax basis of the property steps up to its value at date of death.  In most cases, the basis step-up rule eliminates wholly, or largely, the gain against which the home-sale exclusion is applied, thus mooting your question.

If basis step-up does not occur, however, federal tax code section 121(b)(4) provides that a surviving spouse will get the $500,000 gain exclusion if the residence is sold not later than two years after the date of death of the spouse and if all other conditions are met (i.e., each spouse occupied the property for two years of the five years ending on date of sale; one spouse owned the property for two years of the five years ending on date of sale, etc.).

Let’s explore this topic with several examples. (For the following illustrations, "sale" means close of escrow.)

Illustration 1:  Let's say you bought the house for $100,000 in 1990 and never did improvements.  The $100,000 is your "basis"—the figure used for computing the gain.  If you sell the house for $900,000, your gain would be $800,000 (before any exclusion or basis adjustment).  Note that the $900,000 is the sale price minus closing costs and commissions, but not reduced for any loan paid off in sale.

Illustration 2:  Assume the same facts as in #1 above, but your wife died a few months before the sale and the basis step-up occurred.  The basis at date of sale is $900,000.  You would actually have a slight, non-deductible loss, in the amount of the commissions and closing costs.  The $500,000 gain exclusion is moot because you have no gain.

Illustration 3: Assume the same facts as #1, and you got no step-up in basis because surviving spouse owned the residence as survivor's separate property.  Spouse died October 31, 2016.  Sale closed January 10, 2017.  The taxable gain would be $300,000, which is the pre-exclusion gain of $800,000 less the $500,000 exclusion.  The $500,000 exclusion applied because the house sold not later than two years after the date of death of the spouse (i.e., not later than October 31, 2018).  See federal tax code section 121(b)(4). 

Illustration 4:  Assume the same facts as #3, except sale occurred after that two-year period (i.e., November 1, 2018 or after).  The survivor would be entitled to $250,000 gain exclusion rather than $500,000.

G. Scott Haislet, CPA, Esq. is a tax adviser, estate planner and real estate attorney. You can reach him at (925) 283-1031).

Have a question for a CPA? Ask it here.