Tax Consequences of the Family Home for the Surviving Spouse

Tax discussions with clients who have lost spouses can be challenging, but necessary. There are tax considerations the surviving spouse needs to consider, especially if they owned a home with the decedent. In this post, we’ll discuss the tax consequences of the family home for the surviving spouse, including the implications of selling the house and the step-up in basis for inherited assets.

Selling a Family Home After Death

Sometimes, after a spouse passes away, the surviving spouse must make the difficult decision of selling the family home. If a client is considering selling their house, they should be informed about time-sensitive tax deadlines related to any gain from the sale.

The §121 exclusion allows taxpayers who have a capital gain from the sale of their principal residence to exclude up to $250,000 ($500,000 MFJ) from their income, provided they owned and used the property as their principal residence for at least two out of the five years before the sale.

Surviving spouses are eligible to exclude up to $500,000 of gain from the sale of their home if they meet the following criteria:

• Sell the home within 2 years of the death of their spouse;
• Haven’t remarried at the time of the sale;
• The taxpayer or the late spouse didn’t use the exclusion on another home sold less than 2 years prior to the date of the sale;
• The taxpayer meets the 2-year ownership and use test.

In the event the surviving spouse does not meet the 2-year ownership and use test to qualify for the exclusion of gain, the taxpayer can consider the time of their late spouse’s ownership and use to meet the requirements.

Generally, taxpayers report the capital gain from the sale of a principal residence on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses. Taxpayers who qualify and choose to exclude the gain from the sale of their home and did not receive a Form 1099-S, Proceeds from Real Estate Transactions, do not need to report the gain on their federal income tax return.

Cost Basis Considerations for Inherited Property

Another tax consideration for surviving spouses is the basis of their inherited property. Taxpayers may receive a step-up in basis to the fair market value at the date of death when they inherit property from their late spouse.

The step-up in basis a surviving spouse may receive depends on how and where the asset was owned.

Sole Ownership

For property that the decedent owned by themselves, the surviving spouse receives a step-up in basis to the fair market value of the property on the date of the spouse’s death.

Qualified joint interest

The step-up in basis for jointly held property depends on where the property is owned.

Common-Law States

One-half of the value of jointly held property owned only by the decedent and the spouse is included in the decedent’s estate, regardless of the amount contributed upon purchase. So, to calculate the basis in the property for a surviving spouse, sum one-half of the property’s cost basis and one-half of the value included in the decedent’s estate.

Example: Mr. and Mrs. Smith owned a home together that they purchased for $300,000. Mr. Smith contributed $200,000, and Mrs. Smith contributed $100,000. Upon Mr. Smith’s death, the fair market value of the property is $500,000.

The calculation for Mrs. Smith’s stepped-up basis:

One-half of the original cost basis	$150,000
One-half of the fair market value at death	$250,000
Inherited property basis	$400,000

Community Property States

In community property states, both spouses generally split ownership of assets acquired during their marriage. When one spouse passes away, the total value of the community property receives a step-up in basis as long as half the value of the community property interest is included in the decedent’s estate. This is true regardless of the name of the spouse on the title of the home.

Example: Mr. and Mrs. Park resided in a community property state and jointly owned a home together that they purchased for $300,000. Upon Mr. Park’s death, the fair market value of the property is $500,000.

The calculation for Mrs. Park’s stepped-up basis:

One-half of the fair market value at death	$250,000
One-half of the fair market value at death	$250,000
Inherited property basis	$500,000

Community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Record-Keeping Considerations

It’s always important to remind clients of their tax record-keeping responsibilities. Having accurate and readily available records is especially helpful in times of unexpected events, such as the death of a spouse.

Regarding a home, having updated records can substantiate an increase in the cost basis beyond the original purchase price for a taxpayer, making it easier to calculate the capital gain on the sale. Inform your clients that they should retain records detailing the following information:

• Original purchase price
• Cost of any capital improvements
• Appraisal of the home as of the date of death

Final Thoughts

Difficult situations in taxpayers’ lives arise from time to time. For clients dealing with the death of their spouse, providing timely information about the sale of their home may not only save your client’s taxes but also bring value in their time of need.

This topic will also be covered at the upcoming August 6 webinar, Planning for the Surviving Spouse.

By Ashley Akin, CPA

Sources:

• Essential Tax Guidance for Surviving Spouses: Secure Your Financial Future After Loss – Method CPA
• Publication 559 (2024), Survivors, Executors, and Administrators | Internal Revenue Service
• Publication 551 (12/2024), Basis of Assets | Internal Revenue Service