Partially Inherited Home - Is this taxable income?

February, 04 2022 by Carolyn Richardson, EA, MBA

Hello - My wife inherited 1/4 of her parents' home via a death on deed & was sent a 1099-s listing the gross proceed $. There were a lot of liens on the property so my wife only ended up a net $11,000. Is this taxable income? If so, is the net amount entered on form 8949? 

-Thomas



Hello Thomas,

Thank you for your question regarding the share of a parental home that was inherited by your wife.

First of all, let’s address the amount of cash your wife actually received. It sounds like the property may have had one or more loans, and possibly other types of liens such as liens for delinquent property taxes. These all had to be paid off when the property was sold, but they really don’t have an effect on what you need to report for your tax return. The payoff of these liens or loans is not deductible or used to calculate the gain or loss on a property, whether it is inherited or not.

You may want to refer to our previous blogs on inheriting money or property, located here and here.

These blogs may answer some of your questions, but also explain what a “step up” in basis is, which you will need to know to prepare your return. Essentially, this is where the property is revalued for tax purposes when someone dies. The property is revalued to the current fair market value at the time the person dies. For example, if the home could have been sold on the date your in-laws died for $200,000, then that becomes your wife’s new basis for calculating the gain or loss. This would be true regardless of whether the property had a $100,000 mortgage on it, or back property tax liens for $20,000 – your “cost basis” for tax purposes would be $200,000.

Now let’s assume that she sold the property for $200,000. In that case, there would be no gain or loss. In fact, there might be a loss because of selling expenses, such as real estate commissions. But for now, let’s assume there were no other expenses. If the property sold for $200,000, and there was a $100,000 mortgage and $20,000 of back property taxes due, then the sale would have netted $80,000 of cash. As a ¼ beneficiary of the property, you would think your wife’s tax gain is $20,000 (25% of the $80,000 gain). But that would be incorrect – the tax gain is calculated using the selling price of $200,000, less the stepped-up basis of $200,000, so the gain would be $0. As I stated earlier, the amount of outstanding loans and liens on the property are not considered in calculating the taxes.

As to how to report the sale on your return with regards to the 1099-S she received, the answer to your question may depend on whether the Form 1099-S that she received is for just her share of the sale of the home, or for the entire sale. We’re assuming that there was no trust involved since it appears she received the Form 1099-S personally, and not as a trustee. If the Form 1099-S showed only your wife’s portion of the proceeds ($50,000 in our example), then simply report that as the selling price with ¼ of the property’s stepped-up basis as her cost basis (in this example, the selling price and cost basis would be $50,000 each, resulting in no gain or loss).

If the 1099-S was issued for the entire amount ($200,000 in our example), then you will need to report this using the full amount of $200,000, less the full amount of the stepped-up basis. You should then use the adjustment column on the Form 8949 to adjust out the ¾ of the gain or loss on the property she did not own a share in. If your wife was in charge of selling the house and distributing the proceeds to the other beneficiaries, this is similar to how you report nominee distributions where the account is shared but the reporting form is issued to one person. For example, if the house was worth $200,000 and it was sold for $240,000, that would show a $40,000 net gain, but since your wife owned only ¼ of the property, you would enter ($30,000) in the adjustment column to get to the correct $10,000 gain for your own income tax return.

If there was a trust for your wife’s parents, and your wife was the trustee of the trust, then this advice would not be applicable. Trusts are required to file their own tax returns and report any income that is distributed to the beneficiaries. That would be beyond the scope of this answer to your question, and you may want to consult with a tax professional who is familiar with trusts if that is the case.

Sincerely,
Carolyn Richardson, EA, MBA