Dear Mr. Premack: I read with interest your column regarding a widow’s step-up in basis. My husband recently passed away leaving me as his only heir. We own a farm. Part of it was inherited and part was purchased by the two of us. How would the step-up in basis apply under these circumstances? The farm and our residence are here in Texas. – EW
Your letter deals with the taxes you may owe if you later sell any of your real estate. Capital gain tax is calculated by subtracting the adjusted basis from the net sale proceeds. For instance, if you paid $20,000 for a property (your basis) and you then sell for $120,000, you have a $100,000 capital gain on which tax may be owed. This happens anytime an owner sells an asset that has appreciated in value.
When you inherit a property, your basis may be stepped-up, that is, adjusted upward to match the property’s market value as of the date of death (or as of six months later if special valuation rules are used for estate tax purposes). For example: you and your husband paid $20,000 for a property may years ago but it was valued at $100,000 on the date your husband died. You may be allowed to use the $100,000 value as your basis (“free step-up in basis”). If you later sell for $120,000 you have a $20,000 taxable gain which is far better than the $100,000 gain in the absence of the step-up in basis.
There are some exceptions to those general rules. First, if the property in question is your homestead then it is already exempt from capital gain tax on up to $500,000 gain if sold while you are married and up to $250,000 gain if sold after you are widowed. Second, community property is given a 100% step-up in basis, even though the decedent only owned a one-half interest in the property. Third, separate property is given a step-up in basis only when the owner dies; if the non-owner spouse dies, the owner spouse gets no step-up in basis on the separate property.
You and your husband owned a farm and residence in Texas. Part of the farm was inherited and part purchased jointly by both of you. You must begin by probating your husband’s Last Will in the county of his residence. Hire legal counsel experienced in probate and go through the process of becoming the court appointed Executor of his estate. Doing so will clear title to the property and confirm to everyone that you are now 100% owner of the farm and residence.
Once you are recognized as legal owner due to probate of your husband’s Will, the basis question becomes pertinent. The farm is part inherited separate property and part community property, but I cannot tell from your letter who owned the inherited separate property portion. If the separate property portion came down from your ancestors to you, then it gets no step-up in basis due to your husband’s death. If the separate property portion came down to your husband from his ancestors then when his Will is probated and you are recognized as owner, you do get a step-up in basis to the market value for that portion of the farm. The community property portion of the farm receives a full step-up in basis on both his half and on your half.
Your letter states that you also have a residence in Texas. Again, I cannot tell if the farm is your residence, or if you have a separate homestead elsewhere. If the farm is your residence, then it 1) receives a step up in basis as stated in the prior paragraph, and 2) when you sell, any new capital gain after the step up in basis is applied will be further reduced by your homestead exemption. If you have a separate homestead, transfer of title would also be necessary via probate of your husband’s Will. If the residence is community property then it gets a full step-up in basis, and when you someday sell it, any new capital gain tax is further offset by the widow’s homestead exemption.
Paul Premack is a Certified Elder Law Attorney in San Antonio. His firm has offices in Texas and Washington, and handles estate planning for all ages, probate law and business entity formation issues.
This column first appeared in the San Antonio Express-News (MySA.com) on August 28, 2014. Click here to read it on the MySA website.