Dear Tax Talk,
We inherited a condo that had a mortgage on it in 2010. We had to pay off the mortgage. We rented it for two years, and we sold it in 2014. Do we get any credit for paying off the mortgage of $30,000? When figuring the basis and adding the depreciation, we now have to pay capital gains tax on it. Is there a way to add the $30,000 to the cost basis or get credit some other way so we do not owe taxes on this?
When you inherit property, your basis for tax purposes is generally either the fair market value, or FMV, on the decedent’s date of death or the FMV of the property on the “alternate valuation date” if the executor of the estate chooses to use one. This is known as stepped-up cost basis.
The $30,000 mortgage that you had to pay is not part of the calculation, so let’s take a look at what happens in your situation.
Let’s use an example of someone buying a condo for $125,000 that is worth $200,000 when they pass away and leave it to you. By the way, it still has a $30,000 mortgage that you then pay off. You decide to not rent out the property, and two months later you sell the condo for $200,000. What has happened? For tax purposes, you sold it for $200,000 and your basis in it was $200,000, so there is no tax gain or tax loss. At the end of the day, you end up with $170,000 in your pocket with no taxes paid.
Because you paid the $30,000 mortgage off and rented the property out in the interim, don’t let that confuse the issue. Your tax basis when you started renting out the property would still have been $200,000, which is the FMV. You need to make sure that you started out with the correct basis when you calculated your depreciation for the rental property.
You may want to consider sitting down with a tax professional and going over all of your calculations, including prior year returns, to make sure that you are getting all the tax benefits you are entitled to on this property.
Thanks for the great question and all the best to you.
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