Q: My dad purchased an investment property in 2006 for $150,000. He put my name as joint owner with him. His intent was for me to become the sole owner of the property after his death. He died late last year. Prior to his death, he managed the property and did everything that had to do with the property. He took all the tax benefits and tax deductions having to do with it.
When he bought the property, he and I took out a mortgage, but the lender used his credit only to approve the loan. I have never reported anything in my tax return having to do with the property. With his death, I inherited his share of the property and am now the sole owner.
Do I need to get an appraisal for the home, or can I use online tools to figure out what it’s worth? Many online websites show the home’s value at around $130,000. Can I use that value to set the value of the home when I sell it down the line? Do I only get 50% of step-up value?
I’d appreciate any information you can provide on this issue that can give me some insight into the tax issues involved.
A: First, please accept our condolences on the loss of your father. If you’ve read some of our past columns, you know that we are not fans of how your father set up his financial affairs with regard to this property. As a general rule, we don’t think parents should put real estate in their children’s names (even if they share ownership) solely for estate planning purposes.
Let’s dive into specifics: You and your dad purchased the property for $150,000. Even though your dad took all the tax benefits on the property, his share of the property when he purchased it was worth $75,000. Your share was worth the same. Your dad used the property as an investment property and received rents from the tenants, spent money on repairs and depreciated the property on his income tax returns.
When your dad depreciated the property, his basis for income tax purposes went down. If you and he had sold the property, he would owe tax on the depreciation he took over the years. When he died, you inherited his 50% share of the property at its stepped-up basis.
What does that mean? You inherit his share of the property at its value at the time your dad died. That’s generally a good thing, especially if the property in question has risen in value. If you inherit the property at a higher value, you only owe taxes on the increase in value from the date your dad died.
If you sell your dad’s property within a year or so of his death, the sale price will set the value for the property, so you wouldn’t pay tax on the sale of his share. However, if you sold at a price point higher than the purchase price you might owe tax on your share of the profits.
What happens if, as you suspect, the property is worth less than the purchase price?
If your share is worth $75,000 and you inherited your dad’s share at around the same amount, and if you sell it within a year of your dad’s passing, you’re likely not going to have to pay the federal government any taxes on that sale. (Neither income taxes nor capital gains taxes should be due.)
On the other hand, if the value of the property has decreased, you won’t get the benefit of a stepped-up basis but, rather, a stepped-down basis. In other words, you would inherit your dad’s half of the property at a lower valuation. If you keep the property for another 10 years and the value suddenly skyrockets, you might pay more in tax (because you’ll pay the difference between the inherited value — the stepped-down value — and the current sales price, whenever that is). For this reason, if you are not selling the property anytime soon, you’d want to get somebody to tell you that the property’s value is as high as possible so that when you do sell down the road, you will pay taxes on the difference between the stepped up value and the sales price of the home.
While several online websites show values, we caution readers to take those values with a grain of salt. We’ve seen values fluctuate wildly at times and we’ve seen firsthand how off base some of those valuations can be.
Your best bet is to talk to some good real estate professionals in your area to get a sense of what the property is worth.
There are several other tax issues and questions that could play a part in any decision you make about the property. So talk to your accountant, tax preparer or real estate attorney to go over your inheritance, the stepped-up or stepped-down basis and how to handle the property from a tax perspective, given that even though you owned the property since it was purchased you didn’t take any deductions or depreciation.
In terms of valuation, talk to several real estate agents or brokers who are active in the area where the property is located and ask them to provide a written comparative market analysis for the property. The valuation you receive plus advice from your tax preparer or attorney will help determine your next steps.
(Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through their website, bestmoneymoves.com.)