Death And The Stepped-Up Basis

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Death And The Stepped-Up Basis

Question. My wife and I are retired and are in our seventies. We have two children, and our house is currently worth approximately $300,000. We purchased the property many years ago for $32,000, and currently have a very small mortgage and a $40,000 home equity loan. We are debating on whether to sell the house and take the up-to-$500,000 exclusion of gain, or to let our children inherit the house when we pass on.

What are the implications of all of this appreciation on our estate if we do not sell our house before we die. Must my heirs pay tax on the entire appreciation? How is this covered in the Tax Code?

Answer. This is a very complicated issue, and you must seek advice from your tax advisors. It is especially important now that Congress has enacted a major change in the tax laws — much of which is still under review by the tax experts.

You should also discuss your concerns with your children, although the final decision can only be made by you.

Oversimplified, the basis of inherited property for income tax purposes is the fair market value of the property at the time of the decedent’s death. This is commonly referred to as the “stepped-up” basis rule. This was not changed under the new law.

By way of illustration, you purchased your property 25 years ago for $32,000.00, and over the years have made improvements of $30,000.00. Your basis for tax purposes is $62,000.00. If you sell the property for $300,000.00, without taking into consideration costs or expenses of sale, your profit is $238,000.00.

If you are eligible to claim the up-to-$500,000 gain exclusion,( i.e. you and your spouse owned and lived in the house for two out of the past five years before sale) you will not have to pay any capital gains tax on the sale. (Incidentally, there was a strong move to extend the 5 years to 7 but the real estate community lobbied hard and long and that portion of the new tax law was not changed).

If, on the other hand, you do not sell your property, there are different tax laws that come into play. First, on the death of one of you, the surviving spouse will have to pay no Federal income tax at all. Presumably, your house is titled as “tenants by the entirety”, and thus on the death of one of the “tenants”, the survivor automatically becomes the owner of the property.

However, on the death of the remaining spouse, (and assuming no advance estate planning has been accomplished) your heirs will in most cases receive the benefit of the “stepped-up” basis rule. If the value of your property on the date of your death was $300,000.00, and your heirs sell the property for that amount, then they will not have to pay any Federal income tax on this sale. They receive tax-free benefits of the appreciation during your lifetime. Obviously, if the heirs sell the property for $400,000.00, then they would have to pay tax on their gain, which in our example would be $100,000.00. Keep in mind that we are only discussing income tax and not inheritance or Estate taxes.

Many tax experts in both the Treasury Department and in Congress have expressed concerns that this stepped-up basis rule creates inequities and is a major loophole in the tax laws. Indeed, in the Tax Reform Act of 1976, Congress included a so-called “carryover basis” provision which was designed to prevent beneficiaries from obtaining the stepped-up basis. They were required to carryover the decedent’s basis. However, because there were serious technical problems created by this 1976 Tax Reform Act, in 1980 the carryover basis rules were repealed by Congress. And to my knowledge, the stepped up basis remains live and well.

According to the Tax Code, the stepped-up basis applies to property “acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent. . .” This means that whether the decedent has a will, or dies intestate (without a will) the beneficiary is eligible for that stepped-up basis.

The law further goes on to address community property states, where each spouse has an undivided half interest in community property. In those states, an heir, devisee or legatee obtains the decedent’s half interest from the deceased spouse, and is entitled to a stepped-up basis under the general rules. The surviving spouse is also entitled to a stepped-up basis for his or her half interest if at least half of the community property in question is included in the decedent’s gross estate for tax purposes.

There is, however, an alternative valuation rule which can be adopted. This alternative valuation gives the taxpayer the election to value the property six months after the date of death or at the date of disposition, if earlier. The purpose of this election is to afford some limited tax relief to estates which have experienced a decline in the value of assets during that six month period.

Obviously, the decision on whether to sell your property while you are living or pass it on to your heirs is a very important — and personal — decision. Some people want to make sure their heirs will be properly protected on their death. Other people are primarily concerned they are protected while they are living. Too many people are, unfortunately, house rich and cash poor.

If, for example, you are sitting on a large amount of equity, and if you need cash now, letting your heirs inherit the property at the stepped-up basis will not solve your immediate cash problem.

One transaction that, in my opinion, usually makes no sense is to transfer your property to your children while you are still alive. Under this scenario, your basis in the property becomes your children’s basis, and they will not be able to utilize the stepped-up basis.

There are, of course, many estate-tax planning approaches that may be available to you. Thus, it is critical that you discuss all of these ramifications with your tax advisors at the earliest possible opportunity.

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MARKET WATCH

Single Family Home Activity in the Antelope Valley

In the last 24 hours
1/20/18

New Listings …  45
Sold …  17
Pending …  13
Expd/Wthd/Cancld …  09
Price Increases …  00
Price Reductions …  05
Number of listings* …  935
Average Days on Market …  94
Short sale/pay listings …  08
Equity listings …  832
Bank owned listings …  16
HUD, Corp, Probate and Auction listings …  43
Days of inventory (at the average rate**) …  22.80
Days of inventory (at yesterdays rate**) …  35.96
Actual Number of days of inventory***  …  ∞

View the last 8+ years of data HERE!

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New Listings on the Market

Closed (Sold) Transactions

Pending Units

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* Count includes all ACTIVE and CONTINGENT MLS listings
** Assuming no future growth or reduction
*** At yesterdays depletion rate (∞ indicates negative depletion,
inventory would not be depleted at this sales rate)
ALL DATA WAS DERIVED FROM THE “GREATER ANTELOPE VALLEY
ASSOCIATION OF REALTORS®” AND IS DEEMED RELIABLE.
THE CALCULATIONS OF THAT DATA IS THE
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8 Clever Ways To Zone Off Space In An Open Floor Plan

WRITTEN BY SARAH WARWICK

8 Clever Ways To Zone Off Space In An Open Floor PlanPhoto by Jo Cowen Architects

We’ve fallen for open-plan living in recent years. After all, not many of us have a formal room just for company anymore. And with modern building materials, we don’t necessarily need every room to have four walls to keep it at a comfortable temperature. But although an open plan may bring the space, light, flow and garden views we desire, it can also feel problematic to organize into zones – and prove distracting to share. Enter the glass partition. It makes room division simple yet doesn’t starve spaces of light or compromise the open feel. Decorative, at half or full height, framed or barely visible, a glass partition can work in every environment. Check out these designs.

Cordon off the cooking area. A glass partition is a natural solution when a separation of cooking and relaxing spaces is essential. Here, it’s a framed glass version from above counter height to the apex of the sloping roof.

This division means that the TV volume doesn’t have to be cranked up to drown out the sounds of the exhaust fan, dishwasher and running water when the space is being used for multiple activities, but the whole effect is still open. Notice how the cabinetry, partition framing and sofa are linked through color, while the floor finish is continuous throughout for a pulled-together effect.

 

Make a room within a room. When true separation is required, glass partitioning can divide without losing openness or light. Here, floor-to-ceiling shelving forms one wall, while the glass doors and side panels ensure that both areas benefit from all the windows.

To maximize light, low furniture that sits at or below sill level is a must-have. Opt for window treatments that don’t obscure any of the glass when they’re open or, if privacy isn’t an issue, take a leaf out of this room’s book and go without.

 

Go half way. A half-height glass divider is enough to split the office from the dining area in this home. A height difference between the two areas and a change in floor finish also help separate the work zone from the social space.

A smaller partition like this one is best employed when noise between the areas of an open-plan room isn’t an issue, whether that’s because the two activities are equally quiet or the two zones aren’t used simultaneously.

 

Set off the staircase. When a flight of stairs is part of an open-plan room, it can become a striking feature. Here, surrounding it with glass that includes cross-struts adds to its sculptural value and draws the eye to the cantilevered steps. The glass partition also works to create a natural spot for the L-shaped sofa in a long room, leaving those seated and those using the staircase with a feeling that their spaces are separate.

Adding rugs – such as the textured one here – can also help define large, open spaces. This rug links the seating area and the modern fireplace.

 

Divide a rectangle. Opening a Victorian house from front to back can result in a long, narrow room, so a glass partition can help with the proportions of the resulting space without losing any of the benefits of an open plan. It’s easier to position furniture in rooms that are more square, especially if the fireplaces are still in place.

Here, the central doors open, while the panels on both sides are fixed. If you were considering something comparable for your own home, it would be worth weighing the pros and cons between something like this and a design with bifolds that allow the two spaces to be fully open to each other when desired.

 

Try a transom. A glass room divider can work by creating an entrance to a new part of an open-plan space, like the transom version marking the change from the kitchen to the seating area here. The steel-framed style of the partition elegantly links to the dark cabinetry.

Repeating the look? A high-ceilinged room is the best place for this approach. In a less lofty space, a doorway works better than a transom for maximum head height.

 

Look into the bathroom. In this home, the bedroom and en suite are open to each other except for the glass divider. The upside of using glass in this type of arrangement is that an en suite gets filled with natural light where it otherwise might be windowless and always artificially illuminated. It also allows a beautiful bathtub to be a feature of the bedroom as well as the wash space. In this interior, mosaic tiles that catch the light complement the reflective wallpaper of the sleep space.

If you’re inspired by this arrangement, bear in mind that it’s really for bathroom neatniks only. Discarded towels and plastic shampoo bottles can spoil the look of your bedroom as well as your bathroom with glass in place. And for many people, a closed-off loo may be preferable.

Or screen the bath with translucent glass. When a little privacy is required, translucent glass can conceal a bathroom from a bedroom yet still allow light through.

It’s worth considering how obscure you want to make the partition. Sandblasting allows control over the level of opacity. Window film is an option for a DIY revamp of a partition from see-through to concealing.

 

Combine it with doors. The radical transformation of this beachside house in England involved adding glass at every opportunity to make the most of the wonderful light and views.

The result of this approach is a contemporary-looking home, which is often the case where lots of glass is part of the architecture. But in this area of the house, the designer opted for a nod to classic coastal styling with doors that combine glass and a tongue-and-groove look. The result? The view of the sitting room from the hall looks characterful but also wonderfully light and bright.

Half-glass doors come in all sorts of styles and, with roots in the Victorian era, are often a good shortcut to adding period style.

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