Please remember that I have no idea as to the extent of your technical background, so if my comments here are too basic for you, I apologize.
I'm not sure if you know the exact year when the home was purchased, or what the client's history is in that regard (in other words whether or not there was any deferred gain from a previous personal
residence sale, for example), but if the property was jointly held at the time of the husband's death, she would have received a "step-up" in tax basis for his 50% share of the home to 50% of the Fair Market Value at the Date of his Death; her 50% of the home would be valued at 50% of their original tax basis in the property (either 50% of the original cost or 50% of the adjusted basis if there was a deferred gain from a previous personal residence sale.
If by some chance the property was acquired prior to 1977, the rules
were different at that time.
As far as improvements are concerned, she would be entitled to an increase in basis for 50% of the improvements up to his Date of Death, and 100% of the improvements subsequent to his Date of Death up to the Date of Sale. 100% of the closing costs would also increase her basis in the property.
As you can see, it can get quite involved when a death is involved.
She would be entitled to an exclusion of capital gain
up to the maximum for Single filers or $250,000. She loses her husband's 250L exclusion, but the adjustment
for his 50% to the FMV at this date of death should more than make up for it.
Depending upon what the actual notice says, I agree that a 1040X is the appropriate response, but a copy of the notice should be sent along with the 1040X. Attaching documentation isn't necessary, but given the inquiry, I would probably attach a Schedule which summarizes the basis computation, if nothing to indicate that the proper method was used to determine the adjusted tax basis.
Naturally, what is common in these circumstances, is that certain figures will have to be estimated
as the records may not be readily available. What is acceptable in that regard will hinge upon what type of gain, if any is involved. If after the appropriate basis adjustments, it is unlikely that there could be any taxable gain
, I wouldn't get too concerned about the extent of the estimates.
The biggest adjustment is likely to be the adjustment to the FMV of the husband's 50% interest
in the home as of his Date of Death, & given the real estate market most everywhere, it isn't likely that there was a lot of appreciation in the FMV of the property between his Date of Death & the Date of Sale. The rest, if any, would likely be covered by her $250,000. exclusion, hopefully eliminating any real tax exposure on the sale.
The may be some depreciation recapture involved, depending upon the circumstances surrounding the property's rental and how the depreciation was treated.
Hope this helps.