If you have an elderly parent who is moving to a nursing home or who needs to downsize, think carefully before you advise her to sell her home.
If she has owned her house for a long time, she most likely purchased it for a very low price. If she sells it now, she will have to pay a capital gains tax on the sale price minus the purchase price. That could be a significant capital gains tax – federal capital gain tax of 15-20% plus California income tax of 9.3%.
She could exclude $250,000 in gains based on Internal Revenue Code section 121. IRC Section 121 allows a $250,000 exclusion from capital gains for an individual who has owned the property for two years and has lived in it as her primary residence for two out of the last five years.
However, if she has owned the house a long time, her gain may exceed $250,000. Many of my clients have parents who purchased a home in the Bay Area decades ago and the home is now worth ten or twenty times the purchase price.
If she can afford to keep the home, it would be better to sell it after she passes away and avoid the capital gains tax.
Internal Revenue Code section 1014 changes the tax basis in property to the date of death value when the owner dies. Let’s say mom purchased the home forty years ago for $50,000 and the home is now worth $1,000,000. If mom sells it, she would have to pay a capital gains tax on the difference between the sale price and her tax basis in the home (purchase price plus cost of improvements). But if you receive it on her death, you will get a “stepped up” basis in the home. The stepped up basis is the date of death value. If you sell it for $1,000,000 and the stepped up basis is $1,000,000, then there is no capital gain and no capital gain tax.
I had a client earlier this year who did not do this. Mom had to move to a nursing home and her children sold her home. The gain in the sale was over $700,000 and mom had to pay a big capital gains tax. Mom was elderly and very ill when they sold her home, and she died a few months later. If they would have waited a few months to sell, the family would avoided the big capital gains tax.