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Capital Gains
Taxes Vanish
If you own assets that have gone up in value
(a home, stocks, etc.) you need to know about capital gains,
cost basis and stepped-up basis. If you own a home, you also
need to know about the residence exclusion from capital gains
tax. We hope that the following example and explanation, using
the fictitious Jack and Jill Hill, helps you feel more comfortable
with these important concepts. Follow up with a qualified
advisor if you have questions about your specific situation.
The Facts:
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Jack
and Jill Hill, married in 1950, bought their home in 1960
for $30,000. They took title as 50%-50% joint tenants
(with right of survivorship). |
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Jack
and Jill added a room and made other improvements to the
home that cost them an additional $20,000. |
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Jack
died in 1996. At that time, Jill had the home professionally
valued, and found that she could receive $400,000 if she
sold it (fair market value). |
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After
Jack’s death, Jill filed the necessary paperwork
with the County Recorder, so she’s now a 100% owner
of the home. |
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Jill
still lives in the home, but now wishes to sell it. When
she sells it, she’ll receive $460,000. |
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The
home is a capital asset. When Jill sells it, the gain
will be subject to the capital gains tax rules. |
The Question: When Jill sells the home, how much capital
gains tax will be due?
The Answer: The correct answer is $0. No capital gains
tax will be due. See Rule #1 above. The calculations:
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Item
|
Amount
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Comments
|
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Sale proceeds (net) |
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$460,000 |
What
Jill receives at sale |
Subtract:
Jill’s 50% of cost basis
Jack’s 50% of cost basis
Combined Basis |
$25,000
$200,000 |
$225,000 |
Jill’s share of original cost plus improvements
The "stepped-up basis" for Jack’s share |
| Jill’s
Capital Gain |
|
$235,000 |
Equals
proceeds minus combined basis |
Subtract:
Residence Exclusion |
|
$235,000 |
Up
to $250,000 for a single person, $500,000 for a couple;
if residence for two of last five years |
| Jill’s
Taxable Capital Gain |
|
$0 |
No
capital gains tax is due |
Stepped-Up Basis
The net proceeds from the sale of the home is the
starting point for determining capital gains. Then, subtract
the cost basis (usually original cost plus the cost of improvements).
The result is the amount of capital gain.
Capital assets owned by a person when the person dies, however,
obtain a new cost basis (called "stepped-up basis"
in this case) for capital gains tax purposes. The new cost
basis equals the fair market value of the owner’s interest
at the date of death. Here Jack had a 50% interest in the
home, so Jack’s share gets a stepped-up basis for capital
gains purposes of $200,000 (50% of the $400,000 fair market
value).
Jack’s stepped-up basis passed to Jill, along with Jack’s
share of the home. When added to Jill’s share of original
cost plus improvements (50% of $50,000), that means that Jill’s
current combined basis for the home is $225,000.
Note that this same concept applies to stocks and other capital
assets. Note also that, where an asset has gone down in value,
it actually gets a new "stepped-down basis"
(again based on the fair market value of the asset at the
owner’s death). One last thought on this: if the home
were able to be treated as community property, the basis step-up
would have applied not only to Jack’s 50% share, but
also to Jill’s.
The Residence Exclusion
In 1997, Congress changed the law so that a single
person can exclude up to $250,000 (and a married couple filing
jointly, $500,000) of capital gains on the sale of a principal
residence owned and lived in two of the last five years.
At the same time, Congress did away with the one-time age
55+ exclusion ($125,000) and the "two-year rollover rule"
that allowed capital gains taxation to be delayed if another
residence was purchased within two years of the sale of the
old.
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[From our January / February 2000 Newsletter]
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