Managing your finances following the death of a spouse is often an uphill battle. Thankfully, surviving spouses are entitled to many significant tax breaks under the tax code. Understanding these benefits can help maximize your tax return this year and ensure you manage your assets so as to limit your tax liability in the future.
Filing Your Return
A surviving spouse may file a joint return in the year of their spouse’s death, provided that the taxpayer did not remarry within that year. Additionally, if the widow or widower still has dependent children at home, they may file jointly in each of the next two years following the death of their spouse. Filing jointly is beneficial for many reasons. Notably, doing so increases the taxpayer’s standard deduction.
A surviving spouse filing jointly (and only if the executor has not named a personal representative) should sign the tax return and write in the signature area "filing as surviving spouse." The final tax return should have the word "deceased," the name of the deceased spouse, and the date of death written across the top of the tax return.
For most American families, their biggest asset is their home, but when one spouse dies, the surviving spouse often sells the family home for financial or personal reasons. Generally, any capital gain made on the sale of property (the difference between the amount paid to acquire the property and the amount it was sold for) is counted as taxable income. Fortunately, the sale of one’s primary residence gets beneficial treatment under the current tax law. Single filers can exclude from taxable income up to $250,000 of capital gain, and married filers can exclude up to $500,000 of capital gain.
Because surviving spouses can file jointly even after the death of their spouse (see above), you might be able to use the full $500,000 exclusion. However, this benefit is only available if the following conditions are met. First, both you and your deceased spouse must have used your home as your primary residence for at least two out of the five years prior to the death of your spouse. Second, either you or your deceased spouse (or both of you) must have owned the home for at least two out of the five years prior to the death of your spouse. Third, for the two-year period prior to your spouse’s death, neither one of you could have taken the exclusion on another residence.
Your home, as well as other appreciated assets, such as rental property, stocks and mutual funds, also qualify for a “step-up” in tax basis. This means that when determining capital gain, the value of the property when inherited, rather than the amount originally paid, is used.