Do you Pay Tax on an Affidavit of Heirship Inheritance?

March, 07 2022 by Jean Lee Scherkey, EA

Father died 30 years ago without a Will. Stepmother just sold house in 2021 and children split father's portion of sale (after filing of an affidavit of heirship). Children received a 1099-S. Do we owe taxes? House sold for the appraised value.

-Penny, Texas



Dear Penny,

No matter how many years may pass, the loss surrounding the passing of a parent never completely fades away. It is especially true when it comes to selling the property your parent called home when they died. One of the ways to make the twinges of loss a bit more bearable is to have an understanding of the tax consequences surrounding the sale of your parent's home.

Many states have their own rules regarding the transfer of title on real estate when a person dies without a will. Based on the helpful information you provided, the father died thirty years ago without a will (referred to as intestate). Generally, when a person dies intestate, their estate (their belongings including property, bank accounts, investments, personal items, cars, collectibles, etc.) goes through a process called probate. Probate is a legal proceeding that oversees the administration, accounting, and final distribution of the decedent's (person who died) assets. However, some states have alternatives to probate if the estate's total value is under a specific amount.

At the time of his passing, the father and stepmother owned their home in Texas. Usually, when a person passes away owning real estate, the property cannot be sold or transferred until the decedent's name is taken off the title. If a person, who co-owns their home with their spouse, dies without a will or trust in place, and if the property was not titled in a manner that allowed the decedent's portion of the property to automatically transfer to the surviving spouse, a formal probate proceeding usually takes place.

However, the state of Texas has another alternative to a formal probate proceeding if the decedent's estate is made up primarily of real estate and not much else. This alternative is called an Affidavit of Heirship. Instead of going through probate, the decedent's heirs will file an Affidavit of Heirship in the county where the property is located. Once the signed and notarized affidavit is filed with the local public records, the heir(s) of the property need to wait at least five years for the filed affidavit to be considered accepted and correct. After being on records for at least five years, certain banks and title companies will honor the Affidavit of Heirship and allow the heir(s) to sell or otherwise transfer the property to another party. Keep in mind that not all banks or title companies will accept an affidavit as proof the heir(s) has a right to the property.

Under the current law, property a decedent owned at the time of their passing receives a new valuation (called basis) as of the date of death. Since most real estate appreciates in value over time, the new valuation is often referred to as a "step-up in basis." If the inherited property lost value, there would be a "step-down in basis." The new valuation, or basis, is passed to the person who inherits the property. Let's look at an example.
 

Madeline's dad, Henry, and her stepmom, Gladys, owned an old summer home by the beach in Galveston, Texas. They bought the home over forty years ago for $60,000. Madeline spent all her summers at the beach house and thought of it as her home away from home. Her dad listed Madeline as the heir to his half of the beach house in his will. When her dad, Henry, passed away, the beach house was appraised and had a total fair market value of $200,000. Madeline's one-half interest in the beach house had a basis of $100,000. Three years later, Madeline and Gladys decided to sell the home. The beach house sold for $250,000. Since Madeline's basis in the home was $100,000, and she made no major improvements on the home, she reported a $25,000 gain on her income tax return. ($125,000 (Madeline’s one-half share of the selling price of $250,000) - $100,000 (Madeline’s one-half basis) = $25,000 gain.) Without the step-up in basis, Madeline's taxable gain would have been $95,000! ($125,000 (Madeline’s one-half share of the selling price) - $30,000 (Her dad’s one-half basis in the home) = $95,000.

In your situation, the children who inherited the home through the Affidavit of Heirship would pay tax on the difference between the fair market value of their father's half of the home, as of the date of his passing, and the selling price of the home. Hopefully, an appraisal of the home was done after their father passed away. If an appraisal was not completed, the children may need to find an appraiser who can calculate what the home would have been valued at as of their father's date of death. Any significant home improvements the children paid for between the time they inherited the home and when it was sold would be added to the home's basis and reduce any overall gain. The sale would be reported on the children's Form 8949, Sales and Other Dispositions of Capital Assets and Schedule D, Capital Gains and Losses. If the children did not live in the home as their primary residence for at least two of the previous five years, they would not qualify to claim the $250,000 gain exclusion on the sale of a personal residence. Also, to qualify for the $250,000 exclusion, the children could not have claimed the exclusion on the sale of another home in the last two years. Depending on how the home was titled, the stepmother may or may not have a step-up basis in her share of the home.

Wishing you health, safety, and many happy returns,
Jean