Neighbor chat. House sale, capital gains on sale. Improvements adjusted for today's cost ???

catch22

House sale and capital improvements to calculate capital gains on sale question.

So, house purchased for 'x' $ 20 years ago.
There is a capital gain on the sale of the property, which will be taxable.
Improvements to the property may be used to change the 'cost basis' for calculating full capital gains tax.

My question (below) is that it was stated that the owners made numerous improvements to the property over the years; which did provide for a higher sales price.
One example is, a very nice fence that was placed around the property that cost $5,000 15 years ago, but would cost $15,000 to build today.

The seller, of course, wants to keep the capital gains tax on the sale as low as possible.

It is my understanding that they may use the original $5,000 to change the 'cost basis'; whereas it is suggested they may use the $15,000 cost (when the house was sold), if the fence was installed today, to calculate the 'cost basis'.

In effect, they are suggesting using an 'inflation adjusted' value.

Is this allowed in the IRS tax code for calculating a property sale 'cost basis' to establish the capital gains amount???

Thank you for your time in sorting this conflict of thought about this process.
Catch

yogibearbull

No, only the historic costs can be used for taxable gains and IRS purposes. This is common in formal accounting too.

catch22

Thank you @yogibearbull

I didn't think there were any new 'magical' IRS regs about this long standing process. Apparently, these folks misread the IRS publication for what they thought they were allowed to do to establish the 'cost basis'. Hope they have not filed their taxes yet, using their perceived method.

msf

A little common sense here would go a long way. If one could use current day prices for some of the costs (improvements), then why not also use current price for the base cost as well? Voilà, no capital gain, nada. Problem solved

OF course no one ever said that the tax rules made sense.

sma3

I would assume if they are audited the IRS will want receipts, ie that $5000 check for the fence!
Tell them to be glad their house value went up . We lost money on the sale of our house in CT over 30 years

bee

msf said:

A little common sense here would go a long way. If one could use current day prices for some of the costs (improvements), then why not also use current price for the base cost as well? Voilà, no capital gain, nada. Problem solved

OF course no one ever said that the tax rules made sense.

Isn't that the case when an asset, like a stock...maybe even a house ...is inherited? This "step up basis" provision basically reprices the asset to the date of transfer.

https://investopedia.com/terms/s/stepupinbasis.asp

msf

Be careful what you ask about. You might get more than you bargained for

There were a couple of exceptions to the "usual" step up rule in the past, there's one current exception (in timing), and potentially one in the future. Perhaps others that I'm not aware of.

Step-up in basis has been eliminated twice during the past 50 years, and each time, the change was short-lived.

Step-up in basis was first eliminated by the Tax Reform Act of 1976 and replaced with a carryover basis regime. The carryover basis rules were heavily criticized and repealed a few years later, before they had taken effect.

The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax and adopted a carryover basis regime [no step up] for calendar year 2010 only ...

Congress eventually threw everyone a curveball. In mid-December [2010], Congress retroactively restored the estate tax and step-up in basis for 2010 decedents. However, for decedents who died in 2010, estate executors could opt out of the estate tax and into a carryover basis tax regime.

https://www.aperiogroup.com/blogs/repeal-of-basis-step-up-third-times-the-charm

The current estate tax law generally provides for a step up (or down) to current value as of date of death. However, for estates subject to the estate tax, an executor can elect to do an assessment of all assets in the estate (it's all or nothing) on the alternate valuation date six months after the date of death, assuming that would result in lower federal estate taxes.

The exception to this exception is if an asset is transferred (via sale, distribution, or other method) prior to the end of the six month period, the individual asset is valued as of the date of transfer.

Recent federal and state proposals are floating around to tax billionaires on unrealized capital gains annually based on mark-to-market valuations.

https://itep.org/president-bidens-proposed-billionaires-minimum-income-tax-would-ensure-the-wealthiest-pay-a-reasonable-amount-of-income-tax/
https://www.washingtonpost.com/business/2023/01/17/wealth-taxes-state-level/

Under these proposals there would be no need for a step up because assets would already be valued at their last annual market price. Further, often these proposals are limited to easily priced securities. They might treat real estate and securities differently.