By JUDD MATSUNAGA, Esq.
In my last article, “Moving to Lower Ground” (Feb. 21, 2015), we explored the sad reality that many seniors might be safer if they relocated to a single-level home with easy access from the street, i.e., no steps. We also said that some seniors might want to move to family so they can visit and “check in” on them more often.
We found that, under Proposition 60/90, the sale of your existing home and purchase of the new home can be done without any increase in your property taxes if the new home is: (1) of equal or lesser value; and (2) in the same county or another one of eight counties that participate in Proposition 90’s tax base transfers.
The purpose of this article is to focus on capital gains taxes. Capital gains tax applies to the difference between the sales price and your “cost basis,” i.e., what you paid for it. For many seniors, their cost basis may be $15,000 (what they paid in 1963). However, the sales price might be $515,000 in 2015. That’s a gain of $500,000.
“Say Judd, are you saying that if I sell my home I have to pay capital gains taxes on a $500,000 gain?” Maybe not. This is where the law heavily favors the homeowner. Not only are homeowners allowed to deduct mortgage interest and property tax, but a married couple can sell their home at a $500,000 gain and not owe the IRS a single dime!!!
“Say what? I thought the only way you could avoid paying taxes on your home-sale profit was to use the money to buy another, more-expensive house within two years.” That’s the old law. The Taxpayer Relief Act of 1997 changed all that.
When you sell your primary residence (need to have lived there at least two years), you can make up to $250,000 in profit if you’re a single owner, $500,000 if you’re married, and not owe any capital gains taxes. That means, for most married seniors, you probably won’t have to pay capital gains taxes at all unless your gain is huge, i.e., over $500,000.
“Do you mean we can sell our home in Gardena for a $500,000 profit and buy a smaller home in Orange County to be close to our daughter and her family and not pay a dime in federal capital gains taxes?” In a word, “Yup.” Furthermore, since Orange County participates in Prop 90, you can also take your Prop 13 taxes with you.
“But Judd, our home in Rancho Palos Verdes is worth over one million dollars.” The law is the same — the first $500,000 of gain is exempt for a married couple ($250,000 if you’re single). If you have a gain of $800,000, the first $500,000 is exempt and you pay capital gains taxes on the $300,000. You may not roll it over into a more expensive home.
“I thought the only time the IRS forgives gain is upon death.” That’s right. Your living trust is designed to do just that. A living trust keeps your home in your estate during your lifetime. Upon your death, the child (or children) inherit(s) the home with a forgiveness of gain and a full step-up in basis.
Let’s say your Rancho Palos Verdes home is worth $1,500,000. Although you paid $70,000 in 1960, the entire $1,430,000 of gain would be forgiven if you transfer upon your death. If your children wanted to sell the home so that they can divide it equally, they would receive a full step-up in basis and pay “zero” in capital gains taxes, e.g., “nothing,” “nada.”
“But we want to sell before our death, we don’t drive anymore and want to move to a retirement home.” Then you must pay the capital gain taxes above your personal residence exemption. The good news is that capital gain tax rates are lower than income tax rates, generally, between 15-20%.
“What about me? I’m single now, but I was married for 50 years before my husband died a few years ago.” Now, I’m not a CPA, but I have spoken to CPAs about this. My understanding is that you are treated as a single seller, i.e., the first $250,000 of gain is exempt. However, the good news is that you received a full or half step-up in basis upon your husband’s death.
“Full or half? Which is it?” It depends on how you and your spouse held title. If you held title as “Husband and Wife as Joint Tenants,” you received a half step-up in basis to market value year of spouse’s death. For example, if your husband died last year, half of your $1,500,000 home in RPV received a step-up in basis.
If you now want to sell, you would pay capital gains tax on the following: Sales price ($1,500,000) minus new (half step-up) basis ($750,000) minus single person’s personal residence exemption ($250,000). You would pay tax on a $500,000 gain. At 20%, that would be about $100,000.
If however, you held title as “Husband and Wife as Community Property with Right of Survivorship,” you received a full step-up in basis to market value year of spouse’s death. For example, if your husband died last year, all of your $1,500,000 home in RPV received a step-up in basis.
If you now want to sell, you would pay capital gain tax on the following: Sales price ($1,500,000) minus new (full step-up) basis ($1,500,000) minus single person’s personal residence exemption ($250,000). You would have no gain at all. You would pay nothing in capital gain tax.
“Say Judd, are you saying that if I want my wife to sell our house after I die so she can be close to our daughters (or move in with our son), there could be a huge tax savings on the gain if we hold title as community property with right of survivorship?” That’s exactly what I’m saying.
“But our house is in our trust to avoid probate. How is that treated?” Property held in trust is held in the form it went into the trust, whether “husband and wife as joint tenants” or “husband and wife as community property.” Most likely, if you bought your home 40-50 years ago, it’s “husband and wife as joint tenants” since the law didn’t yet provide for the other.
Therefore, as long as both spouses are still alive, and there is a possibility that the surviving spouse might want to sell the home after the first spouse’s death, say to downsize or move to a retirement home, you need to make sure title to your home is held as “husband and wife with community property with right of survivorship” to ensure full step-up in basis and paying capital gains taxes unnecessarily.
“I don’t want to pay any taxes that I don’t have to. How can we find out for sure?” If any Rafu Shimpo reader wants to know whether or not their home is held as “husband and wife as community property as right of survivorship, “whether or not you have a trust, you can call my office at (310) 348-2995. We would be glad to help you free of charge.
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Judd Matsunaga, Esq., is the founding partner of the Law Offices of Matsunaga & Associates, specializing in estate/Medi-Cal planning, probate, personal injury and real estate law. With offices in Torrance, Hollywood, Sherman Oaks, Pasadena and Fountain Valley, he can be reached at (800) 411-0546. Opinions expressed in this column are not necessarily those of The Rafu Shimpo.