The Tax Consequences of Selling a House After the Death of a Spouse

If your spouse dies, you may have to decide whether or when to sell your house. There are some tax considerations that go into that decision. 

The biggest concern when selling property is capital gains taxes.  A capital gain is the difference between the "basis" in property and its selling price. The basis is usually the purchase price of property. So, if you purchased a house for $250,000 and sold it for $450,000 you would have $200,000 of gain ($450,000 - $250,000 = $200,000).

Couples who are married and file taxes jointly can sell their main residence and exclude up to $500,000 of the gain from the sale from their gross income. Single individuals can exclude only $250,000. Surviving spouses get the full $500,000 exclusion if they sell their house within two years of the date of the spouse's death, and if other ownership and use requirements have been met. The result is that widows or widowers who sell within two years may not have to pay any capital gains tax on the sale of the home.

If it has been more than two years after the spouse’s death, the surviving spouse can exclude only $250,000 of capital gains. However, the surviving spouse does not automatically owe taxes on the rest of any gain. 

When a property owner dies, the cost basis of the property is "stepped up." This means the current value of the property becomes the basis. When a joint owner dies, half of the value of the property is stepped up. For example, suppose a husband and wife buy property for $200,000, and then the husband dies when the property has a fair market value of $300,000. The new cost basis of the property for the wife will be $250,000 ($100,000 for the wife's original 50 percent interest and $150,000 for the other half passed to her at the husband's death). In community property states, where property acquired during marriage is the community property of both spouses, the property’s entire basis is stepped up when one spouse dies. 

To understand the tax consequences of selling property after the death of a spouse, contact your attorney. Find an attorney near you.

How Community Property Affects Estate and Tax Planning

In most states, spouses can purchase and own property separately from one another. However, in certain states – called community property states – if one spouse purchases property, it is considered the property of both spouses. How marital property is owned has implications for both estate and tax planning. 

There are currently nine community property states. They are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A few other states (for example, Alaska) allow couples to opt into community property arrangements. 

Community property is property acquired by a husband and wife during marriage. In community property states, property held in only one spouse’s name can still be community property. For example, the paycheck that a spouse brings home every week is community property even though only one spouse’s name is on the check. If that check is used to buy an asset, then that asset is community property, regardless of whose name is on the account or the asset. 

Property that is not community property is property that one spouse brings to the marriage, inherits, or is gifted. A spouse can turn separate property into community property by putting an asset owned by one spouse into both spouses’ names. 

Depending on the state, partners may be able to change whether property is separate or community via pre-nuptial agreement, post-nuptial agreement, or exceptions in the law. Changing community property into separate property may be appropriate in second marriages or when one spouse is bringing significant separate property into the marriage. For example, if, at the time of the marriage, one spouse receives significant income from owning a business, the spouses may decide that it is appropriate that the business remain that spouse’s separate property and the income from that property will remain that spouse’s separate property. 

One advantage of community property is with regard to capital gains taxes. If one spouse dies, the cost basis of the community property gets “stepped up.” The current value of the property becomes the cost basis. This means that if, for example, the couples’ house was purchased years ago for $150,000 and it is now worth $600,000. The surviving spouse will receive a step up from the original cost basis from $150,000 to $600,000. If the spouse sells the property right away, he or she will not owe any capital gains taxes. In non-community property states, if one spouse dies, only the deceased spouse’s interest (usually 50 percent of the value) is stepped up. 

When estate planning in a community property state, it is important to fully review assets to determine which assets are community property and which are separate property. A surviving spouse in a community property state is entitled by law to half of the community property, regardless of what the spouses may have wanted to do with the property (such as pass it on to children). Community property can be a factor even in non-community property states if the couple owns property in a community property state. 

If spouses move from one type of state to another, it is especially important that they have their estate plan reviewed by an attorney in the new state to make sure the plan still does what they want. Find an attorney near you.