When a decedent’s residence becomes an asset of an estate, the tax treatment of the sale of the residence will depend whether the executor sells it during the course of the administration of the estate or whether the beneficiary sells it after receiving it.
The decedent’s residence obtains a “step-to” in tax cost to its fair market value on the decedent’s date of death. Any capital gain or loss will be measured from the stepped-to tax cost.
If the decedent’s estate plan provides for the distribution of the residence to a beneficiary or the executor distributes it to a beneficiary as a discretionary distribution, the beneficiary takes the residence at the stepped-to tax cost. If the beneficiary subsequently sells the residence without first converting it to business or investment use, any gain is treated as the beneficiary’s capital gain but any loss is not deductible by the beneficiary.
If instead the executor sells the residence during the period of the estate administration, the residence is treated for income tax purposes as a capital asset held for investment purpose. The gain or loss is treated as a capital gain or loss, which may be deductible on the estate’s fiduciary income tax return. This is the case even though the property was the decedent’s personal residence and even if it was not rented during the administration of the estate.
The capital gains tax consequences of the sale of a decedent’s residence should be considered carefully by the executor and beneficiary/ies, especially if the real estate market is dropping. It is best to consult with your Nixon Peabody LLP advisor to obtain the best possible outcome.