When someone passes away owning real estate, selling that property during probate often becomes one of the most significant responsibilities of the Personal Representative (“PR”). While many aspects of a probate real estate sale resemble a traditional transaction, there are several legal, title, and tax issues unique to probate that PRs and their real estate agents should understand before listing and selling estate property.
This article highlights some of the most common requirements and tax considerations that arise when real estate is sold after the owner passes away.
When do I need probate to sell real estate?
If a decedent owned real estate in his or her individual name (either as the sole owner or via tenants in common), probate is typically required before the property can be sold. The probate court must appoint a PR and issue Letters Testamentary or Letters of Administration, which gives the PR legal authority to hire a real estate agent, list, contract for, and convey the property on behalf of the estate.
Probate may not be necessary if the property passes automatically at death, such as through joint ownership with survivorship rights, a beneficiary deed, or via a revocable living trust. In those situations, the surviving owner, beneficiary, or trustee may be able to sell the property without opening a probate estate.
Probate is needed. When does the PR have authority to sell?
A common question is when a PR should engage a real estate agent. Although preliminary discussions may occur before a probate case is opened, the PR generally does not have legal authority to act on behalf of the estate until formally appointed by the court.
Once the court issues Letters Testamentary (if there is a Will) or Letters of Administration (if there is no Will), the PR then has the authority to administer estate assets and list the property and enter into a sale contract on behalf of the estate.
For these reason, PRs may engage real estate agents early on in the process, but it often is advisable to wait until the Court has opened an Estate and formally recognized a PR’s authority before listing the property, in case there is a delay opening the Estate or a buyer is obtained and wants to close quickly. Waiting until the PR has been formally appointed and Letters have been issued is a conservative approach before proceeding with the transaction.
Obtaining an Estate EIN and opening an Estate Bank Account
Following a decedent’s death, the estate becomes a separate tax entity for income tax purposes. After the PR is appointed, they should obtain an Employer Identification Number (EIN) from the IRS for the Estate.
The PR should then open an estate bank account using the estate’s EIN. When the property sale closes, the net sale proceeds are typically disbursed directly into that account.
Keeping the estate bank account also helps maintain proper accounting for the Estate to properly track expenses, income, and disbursements.
The property is listed and a buyer has been obtained. Now what?
1. Setting up the Contract Properly: A frequent mistake occurs when real estate contracts are prepared in the name of the deceased individual. Once a person dies, he or she can no longer legally convey property. Instead, the transaction should generally identify the seller as:
“The Estate of John Doe, by Jane Doe, Personal Representative”
Likewise, all closing documents should be executed by the PR in a representative capacity, not individually. This distinction helps ensure the transaction accurately reflects the legal ownership and authority of the PR, and also ensures that the proceeds be issued appropriately to the Estate via the IRS Form 1099-S.
2. Preparing a Personal Representative’s Deed. Unlike a standard warranty deed used in many conventional real estate transactions, probate sales are often conveyed by a Personal Representative’s Deed. This type of deed is used because the PR is not conveying property that he or she personally owns. Rather, the PR is transferring title in a fiduciary capacity on behalf of the estate.
Title companies and closing agents will generally require a deed reflecting the PR’s fiduciary authority.
3. Other requirements. Some title companies require tax-related clearances, such as a letter from the PR acknowledging that an Estate is not subject to the Federal Estate Tax. Even where no estate tax is ultimately due, title companies may seek confirmation that required estate tax filings have been completed or that the estate falls below applicable filing thresholds.
PRs and real estate professionals should engage with the title company early in the transaction to identify probate-specific requirements and avoid closing delays.
Form 1099-S Reporting
As stated above, when probate real estate is sold, the closing agent should issue Form 1099-S reporting the sale proceeds to the Estate, using the Estate’s EIN. Proper reporting of this helps ensure consistency between the real estate sale, the estate’s income tax return, and IRS records.
Income Tax Considerations
After the closing occurs, the PR should work with a qualified tax professional to determine any necessary tax obligations and filings. One item which is easy to overlook is to determine the tax basis for the real estate. One of the most favorable tax rules affecting inherited property is the general step-up in income tax basis at death.
In most situations, a beneficiary or estate receives a tax basis equal to the property’s fair market value as of the decedent’s date of death. When estate property is sold shortly after death, there is often little or no taxable capital gain because the sales price may be very close to the property’s stepped-up value (plus closing costs).
The estate generally recognizes gain only on the difference between the stepped-up basis (plus closing costs) and the sales price, rather than on the appreciation that occurred during the decedent’s lifetime.
This rule often eliminates substantial built-in capital gains that otherwise would have existed.
If the real estate was used as a rental property and incurred prior deprecation, then the potential depreciation recapture is also often eliminated. For this reason, holding real estate to death instead of selling the property during life is a very effective income tax planning result.
It is generally recommended that the PR coordinate with the real estate agent to obtain a third party appraisal report to determine fair market value at death in case of IRS audit or examination.
Summary
Selling real estate when someone passes away requires early identification of the steps required and coordination among the PR, probate attorney, real estate agent, title company, accountant, and closing agent. For family members and real estate agents, identifying and understanding probate-specific requirements can help ensure a smoother transaction and avoid unexpected delays.
Please contact Mara Peterson and Jeff Cohen if you need assistance with preparing a PR Deed or assistance with a probate estate administration.
