Capital Gains on Home Sale for Widows and Widowers

Selling a Home After Your Spouse Passes

After your spouse passes, you may want to sell your home. You may decide it’s too big, too much to keep up, or holds too many memories, or you may want to move closer to kids and grandkids.

An Overview of Capital Gains on Selling a Home

If you purchase a home, which rises dramatically in value, and you sell it a year later, the IRS requires you to pay a tax on the value rise (the capital gain). After you sell your home, the IRS will charge a capital gain tax of 0% to 20% based on your income and possibly a 3.8% net investment tax. Some home sales will also incur a state income tax

You’re probably not surprised that the taxman wants a share of your home’s value rise. There is some good news, though. Thanks to a preference for homeownership, the government provides exemptions to capital gain on primary residences.

You can exempt a portion of the capital gain from taxes if you owned and lived in the home for at least two years out of the last five. Single homeowners get a $250,000 capital gain exemption. Married couples get a $500,000 capital gain exemption.

If you sell within 2 years of the death of your spouse, you can take the full $500,000 exemption if you meet all other requirements.

What Happens to the Capital Gain Exemption After a Spouse Passes?

If you’ve lived in your home for a long time, your home’s appreciation may be higher than $250,000. As a new single, thinking of selling your home, you may now worry about the tax on the home’s capital gain.

The IRS does allow special treatment of the capital gain for widows and widowers. You likely owned your home jointly with your deceased spouse and both your names are on the deed (or you have right-of-survivorship). If this is the case, after the death of your spouse, you inherit their half of the home.

When you inherit your spouse’s half of the home, you inherit that other half on a stepped-up basis. After your spouse dies, the IRS allows you to value their half of the home at the current fair market value of the home.

Example of Stepped-Up Basis

Assume you and your spouse purchased your home in 1990 for $300,000 and the value of your home in 2020 is $850,000.00. If your spouse dies in 2020, you inherit their half at $425,000. You will still need to value your half at the initial basis of $150,000 (50% of the initial $300,000).

With this stepped-up basis, the new basis for calculating your home’s value is $575,000 ($150,000 + $425,000). If you sell the home at its current market value of $850,000, your capital gain is $275,000. At that capital gain amount, you can exempt $250,000 from the capital gain tax. You may be able to lower the capital gain further if you have paid for home improvements.

Home Improvements Can Reduce Your Capital Gain

The IRS allows you to deduct the amount of money you’ve invested in major home improvements from the home’s final sales price.

Let’s assume over the 30 years you owned the home, you made the following home improvements.

  • You paid $25,000 to remodel your basement in 1995
  • You installed a new HVAC system for $5,500 in 2003
  • You purchased a new roof and new siding for $22,000 in 2015
  • You remodeled your master bathroom for $12,000 in 2018

Your investments in major home improvements total $64,500.

When you subtract the home improvement investments from your capital gain, you are below the $250,000 threshold. Your final capital gain will be $210,500, based on this calculation: $850,000 – $575,000 (the stepped-up basis of the home) – $64,500 (your home improvement investments).

What Home Improvements Reduce Capital Gains?

The IRS allows you to deduct home improvements, but not repairs. The IRS states that home improvement must “add value to your home, prolong its useful life, or adapt it to new uses.”

A kitchen remodel as an “allowable” home improvement

Allowable Home improvements would include:

  • Upgrades to your plumbing system, for example, a new filtration system (but not replacing a leaky toilet)
  • Room additions and major remodels, for example, adding a new bedroom or remodeling a kitchen
  • Exterior improvements, for example, major landscaping, new in-ground swimming pool or, a new fence (but not planting seasonal flowers)
  • New security systems, for example, a built-in wireless network, window and door replacements (if new windows or doors improve the home’s resistance to wind or storms)

Tips for Widows and Widowers to Compute Their Home’s Basis Value

1. Get a current fair market valuation of your home in the year your spouse dies. Even if you plan to sell the home sometime in the future, you will have the paperwork to justify the stepped-up basis of your spouse’s half of the home.

2. Keep records of all major home improvements. If you are not sure which home improvements reduce the capital gain on your home, contact your accountant.

Please contact us if you have any questions.

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