From the Patrick Parker Realty Tax Season Blog Series
Taxes After The Death of A Spouse
We sincerely apologize for your loss and truly understand how difficult this time must be for you. Among the mountains of paperwork you’ve likely needed to deal with recently, taxes are coming due and that’s just another thing to add to the overwhelming pile of paperwork and grief.
We’d like to help you through this difficult time. And while we must tell you to consult with your tax advisor, if your spouse died last year, it of course affects your 2014 income tax return. But there are other tax implications as well.
Here are four of the most important things to know:
1. You can still file a joint return for 2014.
Unless you remarried by Dec. 31, you were technically single at the end of last year, for federal income tax filing purposes. Even so, you’re still allowed to file a final joint Form 1040 with your deceased spouse for 2014 and thereby benefit from the more taxpayer-friendly rules for joint filers. That final joint return will include your deceased spouse’s income and deductions up to the time of death, plus the income and deductions of the surviving spouse (that would be you) for the entire year.
2. You get a basis step-up for inherited assets.
If you appreciated inherited capital gain assets — such as securities and real estate — from your deceased spouse, you’re allowed to increase the federal income tax basis of those assets to reflect their fair market value (or FMV) as of the date of death. Alternatively, you can use the FMV as of six months after the date of death, if the executor of your deceased spouse’s estate (probably you) makes that choice. (Source: Internal Revenue Code Section 1014(a).) When you sell an inherited asset that has received a basis step-up, you’ll only owe federal capital gains tax on post-death appreciation, if any.
- If you and your spouse owned one or more homes together, the tax basis of the ownership interest that belong to your spouse (usually half) is stepped up.
- If you and your spouse owned one or more homes or other capital gain assets as community property in one of the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin), the tax basis of the entire asset is stepped up to FMV (not just the half that belonged to your deceased spouse). This weird-but-true rule means you can sell assets inherited from your spouse and only owe federal capital gains tax on the post-death appreciation, if any. (Source: Internal Revenue Code Section 1014(b)(6).)
3. You get a bigger home sale gain exclusion — but only for a while.
An eligible unmarried individual can exclude from federal income taxation up to $250,000 of gain from selling a principal residence. Married joint filers can exclude up to $500,000. However, you, as the surviving spouse, are not allowed to file a joint return for years after the year during which your spouse died (unless you remarry). Even so, an unmarried surviving spouse is allowed to claim the larger $500,000 joint-filer gain exclusion for a principal residence sale that occurs within two years after the spouse’s death. This is a beneficial rule, but mind the deadline. Since the two-year period begins on the date of your spouse’s death, a sale that occurs in the second calendar year following the year of death but more than 24 months after the date of death will not qualify for the larger $500,000 joint-filer gain exclusion. On the other hand, if you sell during the calendar year after the year of your spouse’s death, you will automatically be within the two-year period.
Of course, being eligible for the larger joint-filer gain exclusion won’t matter if the gain from selling your home is $250,000 or less. That’s certainly possible even with a highly appreciated home, because the basis of any portion of the home inherited from your deceased spouse will be stepped up. And if the home was owned as community property, the basis of the entire home will be stepped up, as explained earlier.
4. You must follow the required minimum distribution rules for inherited retirement accounts.
If you inherited your deceased spouse’s IRA or qualified retirement plan account (like a 401(k) account), be aware that the so-called required minimum distribution rules apply to the inherited account balance. Depending on your spouse’s age when he or she died and your own age, you may have to take a required distribution this year — and pay the resulting income tax hit. You’ll usually get better required minimum distribution tax results if you choose to treat the inherited account as your own account. For details on the required minimum distribution rules for surviving spouses, see: Inheriting Your Spouse’s IRA (Part 1) and Inheriting Your Spouse’s IRA (Part 2).
Warning: You can’t afford to ignore the required minimum distribution rules. Failure to withdraw the required minimum amount for any year exposes you to a 50% IRS penalty. The penalty is charged on the difference between the required amount for the year and the amount actually withdrawn during the year, if anything. The 50% penalty is one the harshest punishments in our beloved Internal Revenue Code, and it can stack up year after year until you start getting things right.
Again, we apologize for your loss.
Keep in mind that this is general information designed to help you put these valuable deductions on your radar. Patrick Parker Realty Agents and Realtors are not certified accountants. Please be sure to check with your tax adviser to see if you qualify for a particular credit or deduction.
Check back in with the Patrick Parker Realty Blog each Tuesday and Thursday for more Tax Season Blog Series’ Posts and sign up for the Patrick Parker Realty eNewsletter to have updates delivered to your inbox monthly.
The Blog Series will cover many topics such as How do I qualify for a home seller break?, How do I qualify for a home buyer break?, Do I have to report the home sale on my return?, What is the gain on the sale of my home?, What Are Home Renovation Tax Credits?, Deducting Mortgage Interest, Taking the First-Time Homebuyer Credit, How to Avoid Taxes on Canceled Mortgage Debt, Tax Incentives as they relate to Life’s biggest transitions, such as Marriage, the Birth of a Baby, Divorce, or the death of a Spouse and much more. New posts in this Blog Series will be published twice weekly.
For more information about paying taxes on the sale or purchase of your home or any other questions you have about this article please speak with your tax professional or visit www.irs.gov.