Q: My wife and her sister were deeded their mother's home 15 years ago. Their mother bought the home 45 years prior. What would be the tax base for determining capital gains?
A: Your wife's tax basis will depend on whether she received the property by gift or by inheritance. Let's start with the assumption that she received it by gift.
In general, the donor's basis (cost plus improvements in the case of purchased real property) becomes the donee's basis when property is received by gift. The donee "steps into the shoes of the transferor" with one exception. If, at the time of the gift, the "fair market value" of the property interest is less than the donor's tax basis in the interest, then the fair market value is the donee's basis for the purpose of calculating a loss on the subsequent sale of the interest.
Fair market value is defined as the amount a willing buyer would pay a willing seller, both having reasonable knowledge of the facts concerning the property and neither being under duress to buy or sell.
For example, if your wife's mother purchased the home in question for $50,000 and added $20,000 in improvements (expenditures that add value to the property or extend its useful life), her tax basis would be $70,000. Your wife receives a gift of a 50% interest in the home at which time the fair market value of the home is $60,000.
If the property was to sell for $90,000 net of selling expenses, your wife would have a gain of $10,000 calculated as follows: Her portion of the sales price, $45,000, less her basis in her 50% interest (50% of $70,000) of $35,000, resulting in a gain of $10,000.
On the other hand, if the property was to sell for $50,000 net, your wife would have a loss of $5,000 calculated as follows: Her portion of the sales price, $25,000, less 50% of the lesser of her mother's tax basis, $35,000 (50% of $70,000) or the fair market value at the time of the gift, $30,000 (50% of $60,000), resulting in a loss of $5,000 ($25,000 less $30,000).
If your wife received her 50% interest by inheritance, then her tax basis is the fair market value of the 50% interest that she received as of the date of her mother's death unless her mother paid estate tax and the executor made the alternate valuation date election. If that is the case, which is rare, then the tax basis would be the fair market value of the 50% interest in the property as the the date six months after the date of death. This election is only available if estate tax is due and the election results in a reduction in the tax.