Estate 1041. Home Sale (Sec 121 Exclusion)

[Factswrite]

Married client with 3 kids died Dec 30, 2021 with no will; all property was in client's name.  Attorney created an estate.  Assets include commercial property(restaurant) held for rent; personal residence; and vacant residence.

Client purchased personal residence for 80K in 2006.  Attorney used the assessed value on tax bill as FMV on DOD, $113K.  Sold in Nov 2022 for $140K net.  Family moved into vacant residence.

How do I apply Sec 121 exclusion since the family(beneficiaries) qualify?

[Just-Lisa-Now-]

Assessed value isnt necessarily FMV, so not a smart move on the attorney's part. 

Did it really increase in value by 27k (close to 25%) in less than 1 year?

[Terry53029]

When you say family, I assume you are talking about the widowed wife and their children. The wife would be eligible for 121, and if a 1099S was issued you report on schedule d (schedule b worksheet) If no 1099S, then you don't need to report. As Lisa said seems like a poor decision on attorney's part, but doesn't really matter 

[sjrcpa]

Estates don't qualify for the 121 exclusion.

The property was in the estate's name when sold?

[BobKamman]

Sometimes it is a very smart move to use the assessed value for certain purposes, like figuring statutory fees and costs, when a low number saves money.  That doesn't mean it's the FMV or appraised value.  In some parts of the country, real estate values increased by 10% to 20% from 2021 to 2022, so I wouldn't rule out some gain.  But more than selling expenses?  What month was it listed, at what price?  Was there a bidding war, or did they have to lower the cost?  

[Just-Lisa-Now-]

sales price was only 140k, doesn't sounds like its in an area with high real estate values

[BobKamman]

The issue isn't high real estate values, it's high real estate appreciation.  In my area, the lower the price, the greater the percentage increase in value.  

[TaxGuyBill]

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@Factswrite wrote:

Attorney used the assessed value on tax bill as FMV on DOD,

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I don't know how your area works, but in my area the valuation for property tax is well over a year before the actual real estate taxes are due.  So it is possible that the "assessed value" is actually from the prior year.

[Factswrite]

Pulled from Realized Marketplace post "Can an Estate Use a Section 121 Exclusion?"

From Section 121 Exclusion called 1.121-1(c)(3)(l):

Trusts. If a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.

From this, I interpret that the estate can qualify since the beneficiaries(the family) qualify for 121 exclusion.  Thoughts?  This is a community property state too.

[BobKamman]

For Section 121, you have to have owned the property.  You said the decedent was the only owner. Doesn't really matter, because the taxpayer is the trust, and the trust neither owned or lived in the property for two years.  it is just a legal fiction.  

[sjrcpa]

Despite the title of that piece, it is referring to a personal residence owned by a Grantor Trust.

You said you have a house owned by an estate.

Apples and oranges.

[rbynaker]

Did the facts change along the way (wouldn't be the first time)?  Where did this "trust" come from?  I thought we were talking about an estate.  For an estate, I'm wondering what the estate "year" is?  Started in Dec 2021 and ended when?  Is it too late to put the Nov 2022 sale into the "next" fiscal year (and hopefully the "final" year so the gain can be passed out to heirs where it might be taxed in a 0% bracket?)

Rick

[joshuabarksatlcs]

@rbynaker nailed it.

The facts given:

Property in H's name (thus, his separate property???  If so, how would being in a community property state be relevant???)

"No will" Should it be extrapolated it to "No living Trust"?

The cited code sections generally have to do with property in a Grantor Trust.  If the attorney correctly used an estate, it probably reflected the extrapolated "no living trust". 

If the property were distributed from the estate to the surviving spouse - even for a nano-second before the close of escrow, making the surviving spouse the seller,  would Sec 121(b)(4) apply?  

Sold in 2022.  Who was the seller?  The Estate or the spouse?

At this point IF the estate was the seller and had not filed an initial return for 2021, @rbynaker 's suggestion might work.

Lotsa IF and MIGHTs...  Nature in this forum.  The devil is in the Facts.

[joshuabarksatlcs]

regarding: If the property were distributed from the estate to the surviving spouse - even for a nano-second before the close of escrow, making the surviving spouse the seller,  would Sec 121(b)(4) apply?  

I need to clarify a couple points.  When someone died without a will, the state law determines who gets the goodies.  Years ago, I was involved in a trust where a beneficiary died without a will.  I remember the distribution from the trust went 50% to the spouse (widow) and 50% to the mother.   I don't know if that's still the CA law.  I rely on the attorney and strictly go by the rule of "don't play lawyer"...

Regarding @rbynaker 's suggestion, a practical problem could be that, with the other assets, the estate might not be ready to close by 11/2023. 

One possibility is to do a retrospective appraisal to ascertain the "true"

FMV.  But then, was a 706 filed?    

[rbynaker]

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@joshuabarksatlcs wrote:

Regarding @rbynaker 's suggestion, a practical problem could be that, with the other assets, the estate might not be ready to close by 11/2023. 

One of many potential problems. 🙂  We're already ~14 months into the life of the estate so I suspect some sort of year has been locked in by now, fiscal or calendar.  I was mostly asking because that's among the many things we don't know.

Who knows how the other rental property may impact things too.  Rental would get a step-up and "fresh" depreciation which might create a loss or maybe it's wildly profitable. <shrug>

No mention of a 706 filed by the estate but if there was I think they're required to use the basis established on the 706 for gain/loss.  In lieu of that, (unresearched) I thought the IRS looks to probate filings to establish basis.  Not exactly my wheelhouse.  So yay, the estate attorney probably saved a few bucks on probate taxes . . . but now somebody has a $27K gain to pay income tax on.  Bad call if that's the estate, maybe not so bad if it's split among multiple beneficiaries and some of them are in a 0% LTCG bracket.  But way too much speculation at this point.

Still a great summary you posted.  Some of the best nut-shelling I've seen this year!

[Factswrite]

Thanks for the feedback.  I understand the consensus that equating a grantor trust with an estate is a stretch.

I'll check with the attorney but I am assuming a calendar year for the estate(DOD was 12/30/21) which does own the properties.  1099S has the estate listed.  This would be the initial tax return(1041).  Could I call this tax return the final return and distribute the gain to the beneficiaries?  I believe that's what rbynaker is suggesting?

No 706 filed.

I will also suggest a retrospective appraisal to the attorney.

[joshuabarksatlcs]

Pardon my bluntness,  but you may want to brush up on a few concepts.

RE: Equating a grantor trust with an estate is a stretch.

Not just a stretch, but I don't know the word for a colossal stretch.

That, however, is not the point.   A revocable trust established during one's lifetime - aka a grantor trust or a living trust - is a disregarded entity for tax purposes.  (Thus those cited sections that appeared earlier.)  The moment the grantor died, assuming it contains the "common" living trust provisions, the trust magically became irrevocable.  The tax code provisions that are applicable to grantor trusts would no longer apply to that trust.

...but I am assuming a calendar year for the estate (DOD was 12/30/21)

Why the assumption?  An estate may establish a fiscal year.  (Whereas, a trust, without a Section 645 election for a qualified revocable trust, has to be on a calendar basis.)  Research how to establish a fiscal year on the initial return??

This would be the initial tax return(1041).   Along the line of  @rbynaker s suggestion, look into the feasibility of choosing a fiscal year ending before November 2022, making the transaction in the second fiscal year??

Could I call this tax return the final return?  

I'm old fashioned, and you can't call something a duck unless if quacks like a duck.  If the estate has not completely wound down at the end of the year (calendar or fiscal), how can you call it (and file a) final return?  Earlier I pointed out a practical problem.  Impliedly, to go with @rbynaker 's suggestion, the estate has to be completed, ended, concluded, finalized, settled, wound down and finished off, by the end of the fiscal year that included the month of 11/2022. 

I will also suggest a retrospective appraisal to the attorney.

Oh, well.  The retrospective appraisal isn't exactly for the attorney, but to establish the proper FMV for the tax filing.  It could very well contradict the attorney's approach (property tax assessed value).  I hope you aren't in CA, where the assessed value for property tax is bound by Prop 13.  

[Skylane]

Hi, late to the party (again) but agree with @joshuabarksatlcs assessment. 
When someone dies intestate, state laws take over…What did probate court say? likely that spouse inherits everything… with stepped up basis as appropriate. Retrospective appraisal (DOD) establishes basis for estate and should be done. Sec 121 does not apply as stated. Can’t comment on prop 13… I’m on the other coast. 

Serious questions about attorneys handling of the matter.

[joshuabarksatlcs]

Can’t comment on prop 13… I’m on the other coast. 

Not just "on the other coast", if you're outside the Golden State, you pretty much can't comment on anything California.

And, as Birdie in You've Got Mail says, "And Wisa Versa"

Happy Sunday.

[BobKamman]

Unanswered here is where and why the assessed value was used.  In Michigan, for example, the probate court filing fee is based on the value of the estate, and if the executor  hasn't yet hired an appraiser, the court says "The fair market value is often arrived at by doubling the state equalized value (SEV) for the property."  In any case, IRS doesn't care what number was used for other purposes, and won't accept anything that is either too high or too low.  

The property may have increased in value from date of death to date of listing, but probably not more than the selling expenses.  This molehill has been turned into a mountain by the false assumption that some number used elsewhere is frozen for eternity as FMV. 

[taxes96786]

I agree with Lisa. Attorney should have researched the FMV for date of client's death to calculate the proper basis for sale or transfer to beneficiaries.

[taxes96786]

Attorneys have specialties. An Estate/Trust attorney doesn't, necessarily, know tax law.

[BobKamman]

As I wrote, "Unanswered here is where and why the assessed value was used."  Tax preparers who think estates can use Section 121 aren't always familiar with the probate process.