Stepped up basis for spouse

[Cyclone]

I have a client that recently lost their spouse.  They had a property they owned jointly together.   The property was a house but not their main home.  They had acquired it back in 1997 using a 1031 exchange and had rented it out for a few years but then decided to make it their vacation home (2nd home).  Both the state where the property is located and the client's state of residence are common law states (Not community property states).

 

They have about a $50,000 capital gain that was deferred with the 1031 exchange.  The property has appreciated an additional $20,000 since the time of the 1031.

 

I have done some research and it sounds like the living spouse receives a stepped up basis in the property on the date of death of the other spouse but it is a "partial step up" of half of the FMV step up amount on the date of death since it was jointly owned.  If the property had just been in the deceased spouse's name then the living spouse would receive a 100% step up.

 

Here is an example:

 

Original purchase price of rental property in 1986:                   $90,000

Improvements:                                                                           $10,000

 

Value of new property acquired in 1031 exchange in 1997:   $150,000

 

Value of property on date of death of 1 spouse in 2014:        $170,000

Sale price in 2014:                                                                  $170,000

Realtor commissions:                                                              $  15,000

 

Depreciation taken during years as a rental:                           $ 35,000

 

Here is how I calculated the taxable gain:

 

Cost basis of jointly owned property (prior to death):               $   65,000  ($90,000 + $10,000 - $35,000)

Cost basis of Surviving spouse (after others death):                $117,500  ($65,000 + $170,000) divided by 2

Add Realtor commissions paid to sell property:                        $  15,000

Adjusted basis of Surviving spouse:                                         $132,500  ($117,500 + $15,000)

Realized gain:                                                                           $  37,500  ($170,000 - $132,500)

 

To determine taxable amount:

 

Depreciation recaptured at 25% rate:                                         $35,000

Difference (taxed as Long term capital gain):                              $ 2,500  ($37,500 - $35,000)

 

Does anyone see any flaws with my logic?  I am not positive how the depreciation recapture is handled with a 1031 exchange.  I also am not sure if it matters how the property was owned (Joint Tenants in common, Joint tenants with Right of Survivorship,) with regard to the partial stepped up basis.  

 

I really appreciate your time to review my long post.

 

 

 

 

             

 

 

 

 

 

[jklcpa]

The one thing that stands out to me is that in your gain calculations at sale you are recapturing 100% of the depreciation taken. I think that only 50% should be recaptured because the one time that depreciation recapture can be avoided is death, and since the 50% of the unit owned by the deceased was included in the estate assets, it had the potential to be taxed at the estate tax rates.

[Cyclone]

That is a very good point.  

 

My client is trying to track down the old tax returns so I can determine how much depreciation was actually taken on the properties and get the other numbers I need.

 

I really appreciate your reply.  Thank you.

[Jack from Ohio]

That is a very good point.  

 

My client is trying to track down the old tax returns so I can determine how much depreciation was actually taken on the properties and get the other numbers I need.

 

I really appreciate your reply.  Thank you.

No need to track down the returns. The rule is ..."allowed or allowable." Just calculate what should have been taken = allowable.