When a property is sold, a person pays taxes on the capital gain and saves taxes on a capital loss which is equal to the amount received on the sale after deducting the property’s basis. Under tax law, basis means the cost of property after adjusting for depreciation. Basis is used to calculate a gain or loss on the sale of a property.
If a person sells a property and later dies before receiving the proceeds from the sale, the gain on the property is the difference between the decedent’s basis for the property and the sale proceeds. When a beneficiary inherits the proceeds from the decedent’s property sale, the gain received by the beneficiary is included in the gross income of the beneficiary[i].
A decedent’s taxable year ends on the date of his/her death. Only the amounts legally falling under the method of accounting used by the decedent should be considered while computing the taxable income for such year. In the case of a cash-basis decedent, any income accrued during his/her lifetime but unpaid until the date of his/her death is treated as income with respect to the decedent (IRD) and excluded from the final return. But it is taxable to the estate of a beneficiary who actually received the payment of the property.
This can be illustrated by an example. X, who uses a cash-basis method of accounting, sold his motor car for $4,000. X died on a date before receiving the sale proceeds. His basis in the motor car was $2,000. The income received by the estate or beneficiary as the income in respect of the decedent (IRD) to be added to the gross income of the beneficiary is $2,000. $2,000 is the difference between the decedent’s basis in the property and the sale proceeds.
When no regular accounting method is used by the decedent, only amounts actually received during the year shall be included in the income. In such a case, the sale proceeds received after his/her death will not be considered as decedent’s income. But if a person who uses accrual basis method of accounting, the income accrued by the sale would be added in his/her income for that year irrespective of the fact when the amount was received[ii].
[i] 26 CFR 1.691(a)-2
[ii] 26 CFR 1.451-1(b)(1)