Ask the Expert: Yes, you owe inheritance tax on house

I inherited a house in 2001. I spent $30,000 to upgrade it for my son, who lived there for several years. Now I plan to sell it. I don't know the value of the house when I inherited it; but assuming it was $235,000, and I sell it for $350,000, do I owe a tax? I know there's no federal inheritance tax in 2010.

That's irrelevant, since you inherited the house in 2001.

Don't guess about its 2001 market value, says Michael W. Alderman, an East Meadow tax accountant. "Retain an appraiser to look at the history of sales at that time. It won't be a contemporaneous record, but it's better than nothing." You also need records of what you spent on capital improvements, so you can back up that $30,000 claim if you're audited. (Remember, a capital improvement is something that permanently increases the value of the property, such as adding a bathroom or putting in new wiring.)

Let's say the house was worth $235,000 when you inherited it, and you sell it for $350,000. We'll assume you net $345,000 after subtracting sale-related expenses (brokerage commissions, legal fees, etc.). Your cost basis in the house is $265,000 - $235,000 original value plus $30,000 of improvements. Your profit is $345,000 minus $265,000. That entire $80,000 is taxable as a capital gain. You don't qualify for the tax exclusion on the sale of a principal residence. You can only claim that exclusion when you sell a house you've owned and lived in for two of the past five years.

The bottom line The tax law governing the sale of inherited assets is the law that was in force when you inherited them.

More information Enter 523 and 551 in the search box at www.irs.gov for IRS publications. TO ASK THE EXPERT: Send questions to Ask the Expert/Act2, Newsday Newsroom, 235 Pinelawn Rd., Melville, NY, 11747-4250, or e-mail act2@newsday .com. Include your address and daytime phone number. Advice in this column is offered as general guidance. Check with your own advisers for details on your specific needs.