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Inherit the Family Home? Tax Consequences for Military Officers

Taxes Estate Planning

As you progress through your career and become a senior military officer or after you retire from the military there is a pretty good chance you'll inherit the family home. There is also a pretty good chance Mom and Dad have lived there for awhile. So, if you sell the house you're going to get hit with a big tax bill, right? Not necessarily. 

Basis "Step-Up" (or "Step-Down)

When a house is sold there is a capital gain or loss. This is determined by subtracting the basis (adjusted for improvements to the property and costs of the original closing) from the sale price (minus sale expenses). This calculation changes when a property is inherited.

When inheriting property the basis changes or steps up (or down) to the Fair Market Value (FMV) on the date of death. So the taxable gain could actually be quite small. Let's look at an example.

  • Mom and Dad bought the house 20 years ago for $50,000 and over the years put $25,000 into improvements. So the adjusted basis is $75,000
  • On the date of the second death the house was worth $150,000
  • You sell the house 6 months later for $155,000 after selling expenses
  • The taxable gain is $5,000 and is a long-term capital gain regardless of how long after death the house is sold. The adjusted basis established by your parents is irrelevant.
  • Assuming you receive the proceeds of the sale, you will report the $5,000 gain on your tax return.
    • If you did not take title of the house, the sale will be reported on the estate's tax return, but you will receive a K-1 which includes the proceeds of the sale to "move" the gains to your tax return

What If You Sell It for Less Than the FMV?

It is certainly possible that you could sell the property for less than the FMV. In this case as long as no one used it as a personal residence (excluding renters), then you could consider the property as being held for profit and deduct the loss.

Good Records are Important

To cross all your "T's" and dot all your "I's" it would be good to get an appraisal done as soon as possible after the second death to establish the FMV. Other options, but not as thorough would be to have a realtor do a comp on it for you or I suppose you could check the value on an on-line site like Zillow.

Estate Administration is Complicated

What I've described here only applies to Federal Income Tax. There is at least the possibility that estate taxes could be due on a Federal or State level. In some States, there are also inheritance taxes.

You're smart enough to handle this, but it will take time. You might want to consider getting some help with probate from a qualified estate planning attorney and help with the taxes from an Enrolled Agent (EA) or CPA.


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