Basis of real property in revocable trust settlor's death

[mbigelow]

Settlor placed her personal residence (never used as business or rental property) in a revocable trust. She died and the trustees sold the house in accordance with the trust. Is the house allowed a step-up basis?

[Bees Knees]

TTB Deluxe/Small Business Edition, page 21-33:

Generally, the basis of property acquired from a decedent is its FMV on the date of death...

...Property acquired from a decedent includes property included in the probate estate, property in the decedent's revocable trust, property passing by beneficiary designation, and other property includible on Form 706...

[mactoolsix]

And after compiling all the expenses, you'll probably find there is a deductible loss.

[Roland Slugg]

And after compiling all the expenses, you'll probably find there is a deductible loss.

Can you provide a cite to the Code, Regs or other authoritative source for that comment? This has been discussed many times on this forum, and the general consensus seems to be that unless the house was rented out after death, as legitimate rental property, that a loss on its sale is nondeductible. That is my opinion, as well, but I would be happy to learn otherwise.

[TaxGuyBill]

Can you provide a cite to the Code, Regs or other authoritative source for that comment? This has been discussed many times on this forum, and the general consensus seems to be that unless the house was rented out after death, as legitimate rental property, that a loss on its sale is nondeductible. That is my opinion, as well, but I would be happy to learn otherwise.

Read David Fogels comments on this post on TaxProTalk:


In a nutshell, one "Service Center Advice" document says "no", but an IRS Publication and quite a few Tax Court cases say that it is deductible.

[Bees Knees]

In a nutshell, one "Service Center Advice" document says "no", but an IRS Publication and quite a few Tax Court cases say that it is deductible.

IRS Pub 559, page 16

Sale of decedent's residence. If the estate is the legal owner of a decedent's residence and the personal representative sells it in the course of administration, the tax treatment of gain or loss depends on how the estate holds or uses the former residence. For example, if, as the personal representative, you intend to realize the value of the house through sale, the residence is a capital asset held for investment and gain or loss is capital gain or loss (which may be deductible). This is the case even though it was the decedent's personal residence and even if you did not rent it out. If, however, the house is not held for business or investment use (for example, if you intend to permit a beneficiary to live in the residence rent-free and then distribute it to the beneficiary to live in), and you later decide to sell the residence without first converting it to business or investment use, any gain is capital gain, but a loss is not deductible.

I don't think there is any question that an estate can sell the decedent's house and deduct a loss provided no beneficiary used the house as a personal residence. I have never seen any discussions on this message board claiming you can't deduct a loss.

The issue has always been: "What is the basis for deducting the loss?"

In other words, if the estate sells grandmas personal residence for $150,000 three months after her death, but had to put $5,000 into it to fix it up to get it ready for sale, I would argue the FMV at death was $145,000. Thus, basis equals $150,000 ($145,000 FMV + $5,000 fix up costs). No gain or loss.

[Bees Knees]

There is a TV show on the home improvement network called "Buying and Selling", where the hosts of the show (who also host the show "Property Brothers") help people fix up their homes to sell and then find them a new house to purchase.

One theme that is always made clear in the beginning when they evaluate the home is that the house is always worth less than the homeowners believe, because it needs some fixing up before it can be put on the market to sell. The real estate agent always says the true market value is less than what the homeowners expect, because the property needs these repairs before anyone will buy the house.

Thus, when determining the step-up in basis for a decedent's home, the FMV of that home at the time of the decedent's death has to be adjusted down for the cost of fixing it up before the sale. You can't claim an over inflated value of the home and then pretend that the fix up costs create a deductible loss when the estate sells the home.

[kathyc2]

IRS Pub 559, page 16



I don't think there is any question that an estate can sell the decedent's house and deduct a loss provided no beneficiary used the house as a personal residence. I have never seen any discussions on this message board claiming you can't deduct a loss.

The issue has always been: "What is the basis for deducting the loss?"

In other words, if the estate sells grandmas personal residence for $150,000 three months after her death, but had to put $5,000 into it to fix it up to get it ready for sale, I would argue the FMV at death was $145,000. Thus, basis equals $150,000 ($145,000 FMV + $5,000 fix up costs). No gain or loss.

But, if the FMW is 150K and it sells for 150K and there are 15K in realtor fees and closing costs, would there not be a 15K loss?

[Bees Knees]

But, if the FMW is 150K and it sells for 150K and there are 15K in realtor fees and closing costs, would there not be a 15K loss?

How can a house be worth 150K if it costs you 15K to sell it for 150K?

FMV is defined as what a willing buyer will buy something, and what a willing seller will sell something for, both having knowledge of all relevant facts. If that willing seller knows it will cost him 15K to sell something, he has to take that into consideration when deciding what to sell it for. Thus, in the mind of the seller, he knows he is selling it for $135,000 after paying for the expenses needed to sell it.

Its like selling food in a grocery store. If you know you have to pay $10 to the butcher for that steak, are you going to sell it to your customers for $10 and ignore all your overhead costs and profit margin? You can't claim the steak is only worth $10 to a willing buyer. The FMV of anything you sell has to include all of the things you need to pay before being able to sell it.

[kathyc2]

How can a house be worth 150K if it costs you 15K to sell it for 150K?

FMV is defined as what a willing buyer will buy something, and what a willing seller will sell something for, both having knowledge of all relevant facts. If that willing seller knows it will cost him 15K to sell something, he has to take that into consideration when deciding what to sell it for. Thus, in the mind of the seller, he knows he is selling it for $135,000 after paying for the expenses needed to sell it.

It sounds like you are saying the FMV of buyer is 150K and FMV of seller is 135K? How can FMV be different for the 2 parties in the transaction?

[mbigelow]

How can a house be worth 150K if it costs you 15K to sell it for 150K?

FMV is defined as what a willing buyer will buy something, and what a willing seller will sell something for, both having knowledge of all relevant facts. If that willing seller knows it will cost him 15K to sell something, he has to take that into consideration when deciding what to sell it for. Thus, in the mind of the seller, he knows he is selling it for $135,000 after paying for the expenses needed to sell it.

Its like selling food in a grocery store. If you know you have to pay $10 to the butcher for that steak, are you going to sell it to your customers for $10 and ignore all your overhead costs and profit margin? You can't claim the steak is only worth $10 to a willing buyer. The FMV of anything you sell has to include all of the things you need to pay before being able to sell it.

When you sell it for 150K to a willing buyer in an open market, the FMV is 150K. It seems to me in this example that the seller's basis would be 135K, increased by the 15K invested to get it ready for sale, resulting in no gain or loss. If, on top of that, you had commissions, legal fees, etc., those costs could then create a loss. A buyer is not going to pay more for the item simply b/c the seller has to incur costs to sell the item, unless those costs materially improve the item in question.

[New York Enrolled Agent]

How can a house be worth 150K if it costs you 15K to sell it for 150K?

FMV is defined as what a willing buyer will buy something, and what a willing seller will sell something for, both having knowledge of all relevant facts. If that willing seller knows it will cost him 15K to sell something, he has to take that into consideration when deciding what to sell it for. Thus, in the mind of the seller, he knows he is selling it for $135,000 after paying for the expenses needed to sell it.

Bees - I'm not sure your analogy about the butcher in a retail business is valid. But that's not the issue.

Suppose the FMV of the house is the $150K and a willing buyer is found who has $150K in cash to complete the purchase. Unfortunately, the buyer has a premature death and the deal cannot be finalized.

The willing seller now turns to a real estate agent who finds another willing buyer with $150K cash. For argument's sake the re commission is $15K. Are you suggesting that the FMV is now different because there was an expense of sale?

I've never heard anyone else espouse your theory that expenses of the sale are part of the calculation of FMV. Part of the amount realized - there is a difference of the $15K depending on the circumstances - but it seems to me the $150K = FMV in either case.

[taxea]

Doesn't real property in a revokable trust become the property of the beneficiaries at time of death? I thought revokable meant that the trust became null and void and all assets immediately became the property of those named in the trust. If this is true, then the property should have been deeded to the named parties and sold outside of the trust as their property.

[Bees Knees]

I have to back track just a little on my previous post. Reg. §20.2031-1(b) says the value of every item of property includible in a decedent's gross estate is its fair market value at the time of the decedent's death...."The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts...."

Key here is it is one price, not two. FMV is thus the same for both the buyer and the seller.

The only point I am trying to make here is that the step up in basis is based on the FMV at the time of death. FMV is not necessarily the gross selling price three months later. FMV can be less than that amount if it is going to cost you some money to sell it at that price.

To illustrate, lets say the house is listed at $150,000 and the seller is willing to pay the 15K in closing costs. A buyer comes along and is willing to pay $140,000 because he is a realtor and knows how to close it without the seller having to incur closing costs.

Now what is the FMV? How can you say it is 150K when a willing buyer and a willing seller agree to transfer the property for 140K by saving on some of the closing costs? And how can the FMV be 150K one second but then 140K another second merely because the buyer knows how to do some of the labor himself?

Thus, FMV at the time of death and the corresponding step-up in basis can be a grey issue. If you are going to claim a loss on the 1041 for the sale of a house, be prepared to have the IRS challenge your valuation.

[Burke]

Doesn't real property in a revokable trust become the property of the beneficiaries at time of death?

Not necessarily. Depends on the terms of the will/trust.

I thought revokable meant that the trust became null and void and all assets immediately became the property of those named in the trust. If this is true, then the property should have been deeded to the named parties and sold outside of the trust as their property.

Revocable means it can be revoked by the grantor while living. While it is used to avoid probate for the most part, and can be distributed easily and conveniently, it doesn't mean that it always is. Sometimes the trust becomes permanent.