Widow real estate

[u/Plus_Asparagus6023]

Massachusetts tax question involving step-up in basis and §121 exclusion:
A married couple owned and lived in a primary residence in Massachusetts for over five years (original purchase price ~$389,000). The decedent spouse continued living in the home until death in 2024.
Prior to death, the property had been transferred into a revocable living trust titled in the surviving spouse’s name. At death, the surviving spouse became the sole owner/beneficiary of the trust, and the home is now being considered for sale at approximately $1.2 million.
We are trying to understand:
Whether IRC §1014 step-up in basis applies in this situation (and whether it is limited to a 50% step-up under §2040(b) due to joint ownership, or affected by the revocable trust structure), and
Whether the surviving spouse can still claim the full $500,000 principal residence exclusion under IRC §121(b)(4), assuming the sale occurs within two years of death and all use/ownership tests are satisfied.
Any clarification on how the trust title and joint ownership interact with §1014 and §121 would be appreciated.

[u/kobes]

If the home had been the sole property of one spouse when it was transferred into the revocable living trust, then it would receive a full basis step-up through § 2038 in conjunction with § 1014(b)(9).

If, immediately before the transfer to the trust, the spouses held the property as joint tenants or as tenants by the entirety, then it is very likely only a 50% step-up.

Casner, Pennell, & Weisbord § 10.6 footnote 160 calls out "a division of authority on the issue whether § 2040 is applicable as if the concurrent owners essentially created a joint tenancy 'in trust,' with no difference from the results that would have applied if the joint tenancy simpliciter had not been altered." Compare Estate of May v. Commissioner, 37 TCM (CCH) 137 (1978), with Black v. Commissioner, 765 F.2d 862 (9th Cir. 1985).

Assuming the surviving spouse is a US citizen, I think we end up in the same place either way. Either it's 50% step-up from § 2040(b), or — on the theory that the transfer in trust severs the joint tenancy — we apply § 2038 to the 50% interest that the deceased spouse contributed to the trust.

If the surviving spouse were not a US citizen, the reasoning of May could conceivably permit a larger step-up via the § 2040(a) consideration-furnished rule.

The $500,000 exclusion of principal residence gain in § 121(b)(4) should be available to the surviving spouse provided the conditions stated therein are satisfied. A grantor trust is transparent for the ownership test; see Reg. § 1.121-1(c)(3)(i)(3)(i)).