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Surviving spouse puzzled over stepped-up basis

DEAR BENNY: If a new appraisal of real estate is done at the time of the death of one of the owners — my husband — will that give a stepped-up basis for computation of capital gains taxes rather than the original purchase price when the property is eventually sold?

Our house has more than doubled in value since we first bought it. — Billie

DEAR BILLIE: Congress is currently struggling with major tax issues, one of which involves the “stepped-up” tax basis.

Basis is generally the price you paid for the house. To determine your profit (called “gain”), you take your basis and add any major improvements you made over the years. That is called the adjusted basis. You take your sales price, deduct such things as real estate commissions and get the adjusted sales price. Your gain is the difference between the adjusted sales price and the adjusted basis.

Up until the end of 2009, the tax law said that on the death of a property owner, the basis of the inherited property was its value as of the date of death. In other words, the basis was “stepped up.” However, for year 2010, this “step up” is not applicable. Instead, heirs assume — or carry over — the basis of the deceased owner but can elect to increase that basis up to $1.3 million. In your case, since you would be a surviving spouse, the basis can be increased by an additional $3 million.

This really does not impact on middle-class Americans, unless your house is extremely valuable. But depending on what Congress does this year, the old stepped-up basis should be back on the books in 2011.

DEAR BENNY: My brother, sister and I have inherited a condo through the court probate process from our father. The condo has negative equity due to an equity line drawn on the condo prior to my father’s death. Because the probate process passed the condo to the three of us, how do we remove ourselves from legal responsibility to the condo considering that we do not want to assume the liability of the loan? Do we need to do anything assuming the loan is in our father’s name only? What can we do so that we are not associated with the eventual foreclosure? -Brandon

DEAR BRANDON: Did your father’s estate have other assets? If so, those assets should have been used to pay off — or at least pay down — the existing mortgages on the condominium.

Normally, to satisfy creditors of your father’s estate, the condominium would have been sold and the sales proceeds used to pay off the creditors. I have to assume, however, that the property could not be sold because there was no equity there.

The banks holding the mortgages can be paid only out of the sales proceeds or any other available assets of the estate. You all — as heirs — are not personally liable for those obligations.

If the property is the only asset of the estate, you all could possibly execute disclaimers — depending on your state law — and walk away from the property and let the bank deal with it. The bank would probably need to open an estate in order to foreclose, but this would not impact in any way on your credit.

A disclaimer is a legal concept whereby you make it clear that although you have the right to inherit the property, you have no interest in doing this. However, state laws are different and you will have to discuss this with your probate attorney. There are often time limitations in which you have the right to disclaim, and it may already be too late to go that route.

Another possibility: Have you considered trying to sell as a “short sale”? This is a procedure whereby you — or your real estate agent — find a buyer who wants the condo but is only prepared to pay an amount which is less than the existing mortgages. Although banks often take an incredibly long time to process and approve such sales, it is something you may want to consider.

Finally, talk to your mortgage lenders about a deed-in-lieu of foreclosure. This means that instead of foreclosing on the property, the three of you will deed the property back to the bank, and you will be released of any further financial or legal obligations. If there is only one mortgage (deed of trust), or if both mortgages are held by the same bank, then this may be a possibility. However, if the first and second trusts are held by separate lenders, you will have problems getting anyone to accept the deed-in-lieu.

Benny Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to benny@inman.com.

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