Dear Tax Talk,
Here is the story:
a) 1965: My aunt buys an apartment.
b) 1991: My aunt deems me a joint tenant of her apartment.
c) 2007: My aunt dies and I inherit the remaining half of the apartment.
d) 2007: I convert the property to a rental property.
e) 2013: I sell the rental property.
Question: Is the “basis” of the apartment: a) the market value at the time of conversion; b) the market value of half of the property at conversion plus half the value at either the time of purchase or the time of joint tenant creation? How do I figure the basis as a joint tenant?
Your story is not uncommon. When your aunt made you a joint tenant on the apartment, Uncle Sam considered this as a gift of a 50 percent interest in the property. Joint tenancy is a form of property ownership that has “rights of survivorship.” This means that when your aunt died, you as the surviving owner received her interest without having to go through the legal process of probate. Probate is a legal proceeding that takes time and generally the services of an attorney to transfer title of property to heirs if there is a will, or if there is no will, to the persons designated by law as the heirs.
At the time you were made a joint tenant, your basis in the 50 percent interest had the same basis as it did in the hands of your aunt. This is known as a “carryover basis.” Let’s assume that your aunt acquired the apartment in 1965 at a cost of $80,000 and made no other improvements that added to her basis. In 1991, when she added you as a joint tenant, your basis in your 50-percent interest was $40,000 (half of $80,000).
Moving on with your story, property that is inherited at death receives a “step up” in basis to the fair market value at the time of death. Let’s assume that when your aunt died in 2007 that the apartment had a fair market value of $400,000. You now inherit her 50 percent interest and your basis for this is $200,000 (50 percent of $400,000). Your entire basis in the apartment is now $240,000 ($40,000 plus $200,000).
When you converted the apartment to rental property in 2007, you should have started to depreciate your $240,000 basis. Depreciation is an annual deduction of a portion of your basis in the rental property using IRS depreciation tables. The depreciation that has been deducted reduces your basis in the property.
Now, let’s assume that you had claimed depreciation of $50,000 from 2007 until now. Your current basis would be $190,000 ($40,000 plus $200,000 minus $50,000).
As you can see, there can be a big difference in your basis when receiving property as a gift versus inheriting it. If your aunt had put the property in a revocable living trust, she could have avoided the cost of probate on the apartment and let you inherit it with a “stepped-up basis.” A good estate planning attorney could have helped her to accomplish this.
Ask the adviser
To ask a question on Tax Talk, go to the “Ask the Experts” page and select “Taxes” as the topic. Read more Tax Talk columns.
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.