Selling an Inherited Home: Basis, Tax and Reporting

Your basis: fair market value at death

Under IRS Publication 551, the basis of property inherited from a decedent is generally one of the following:

• the fair market value (FMV) of the property at the date of death;
• the FMV on the alternate valuation date, if the personal representative chooses it;
• a special-use value for farm or closely held business real property, if chosen for estate tax purposes.

Publication 523 adds that if a federal estate tax return (Form 706) was filed or required, “the value of the property listed on the estate tax return is your basis.” If Form 706 was not required, the basis is the appraised value at the date of death for state inheritance or transmission tax purposes.

When an estate files Form 706, beneficiaries generally receive a Schedule A (Form 8971) from the executor. Certain beneficiaries must use that value as their initial basis, and Pub 544 points to penalties for inconsistent basis reporting.

Special cases: spouses and gifts back to the decedent

The IRS lists nine community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. For a decedent who died in 2010, Pub 523 refers to Pub 4895 for special rules.

Holding period and tax rate category

Publication 544 states: “If you inherit property, you are considered to have held the property longer than 1 year, regardless of how long you actually held it.” The Form 8949 instructions confirm that a disposition of inherited property is generally reported “as a long-term gain (or loss) regardless of how long you held the property.”

See capital gains on a home sale for rates and calculation.

When the home becomes your main home (Pub 523)

If you move into the inherited home and later sell it, the section 121 exclusion may apply. To claim the maximum exclusion of $250,000 (or $500,000 if married filing jointly), you must meet the eligibility test, including:

• Ownership: you owned the home for at least 24 months (2 years) out of the last 5 years before the sale;
• Residence: you lived in it as your residence for at least 24 months in that period. The months need not be continuous; a total of 730 days is required.

A surviving spouse who has not remarried may count the time the late spouse owned and lived in the home. The surviving spouse may also claim up to $500,000 if the home is sold within 2 years of the spouse’s death and other conditions are met. A partial exclusion may be available if you do not meet the full test.

If you sell your main home at a loss, Pub 523 states: “You can’t deduct this loss.”

Reporting the sale to the IRS

The person responsible for closing, generally the settlement agent listed on the Closing Disclosure, is generally required to file Form 1099-S to report the sale. The Form 1099-S instructions list a bequest among transactions that are not reportable, because it is not a sale or exchange.

On your own return:

1. Report the sale on Form 8949, Part II (long-term), and enter “INHERITED” in column (b), Date Acquired.
2. Carry the totals to Schedule D (Form 1040).
3. If you received a Form 1099-S, Pub 523 says you must report the sale on Form 8949 “even if you have no taxable gain to report.”
4. If you don’t use actual cost as basis, the Form 8949 instructions ask you to attach an explanation of your basis.

Keep the date-of-death appraisal, any Schedule A (Form 8971) and closing documents. Transfer taxes and fees paid as a seller can be treated as selling expenses, per Pub 523 (see closing costs).