Whenever you sell a home, you should understand that special tax rules apply if the house you are selling is inherited.
So many people ask themselves if they will be exempted from the hundreds of thousands of dollars of taxes if they sell a house they inherited. The simple answer is no.
Selling a house that you inherited does not exempt you from any of the taxes. The only benefit that you get is the stepped-up basis rules for any property that is inherited.
Therefore, that means that whenever you sell an inherited property or a home, you are not excluded from the taxes.
The tax law provides homeowners with very generous tax exclusions when they sell their property. Up to $250,000 of any gain from such a sale received by a single homeowner is tax-free. For married homeowners filing jointly, up to $500,000 of gain is excluded from income.
To qualify for the exclusion, the home must have been used as the main home for two years out of the prior five years before the sale. At the time you inherit a home, you will not qualify for this exclusion. You will have to move into the home and live there for at least two years to be eligible.
However, you may not really need the exclusion because of the stepped-up basis rules.
Basis means an asset’s cost for tax purposes. To determine whether you have a profit or loss when you sell a property, you subtract its basis from the sale price.
If you have a positive number, you have a gain. If you have a negative number, you have a loss. The basis of a home you buy or build is its cost, plus any improvements you make while you own it. See Determining Your Home’s Tax Basis for details.
However, a home’s tax basis is defined in a different way when someone inherits a home after the owner dies. When you inherit property after the owner dies, you automatically receive a stepped-up basis. This means that the home’s cost for tax purposes is not what the now-deceased prior owner paid for it. Instead, its basis is its fair market value at the time of the prior owner’s death.
This will usually be more than the prior owner’s basis. The bottom line is that if you inherit property and later sell it, you pay capital gains tax based only on the value of the property as of the date of death. If you sell an inherited home for less than its stepped-up basis, you have a capital loss that can be deducted assuming you do not use the home as your personal residence.
However, only $3,000 of such losses can be deducted against your ordinary income per year. Any excess must be carried over to future years to be deducted.
When you inherit property, such as a house or stocks, the property is usually worth more than it was when the original owner purchased it.
If you were to sell the property, there could be huge capital gains taxes. Fortunately, when you inherit property, the property’s tax basis is stepped-up, which means the basis would be the current value of the property.
For instance, if you inherit a house that was purchased several years ago for $100,000 and it is now worth $300,000. You will receive a step-up from the original cost basis from $100,000 to $300,000. If you sell the property right away, you will not owe any capital gains taxes.
If you hold on to the property and sell it for $450,000 in a few years, you will owe capital gains on $100,000 which is the difference between the sale value and the stepped-up basis.
On the other hand, if you were given the same property, as opposed to receiving it upon the owner’s death, the tax basis would be $100,000. If you sold the house, you would have to pay capital gains taxes on the difference between $100,000 and the selling price.
The only way to avoid the taxes is for you to live in the house for at least two years before selling it. In that case, you can exclude up to $250,000 or $500,000 for a couple of your capital gains from taxes.
Inheriting a house can cost the heirs money. Heirs may have to pay a variety of state and federal taxes, which may be due immediately or if they sell the property later.
The government exempts some property from taxes and offers ways to reduce taxes, depending on the heir’s circumstances. In some cases, owners who inherit property and later sell it may be able to claim a tax loss.
Although the federal government suspended the estate tax for 2010, it is scheduled to return in 2011 for estates worth over $1 million.
Taxes on estates worth that much including real estate, stocks, and bank accounts will be paid by the estate, rather than the heirs. Several states levy estate taxes of their own, though others, such as California, do not. Beneficiaries pay federal inheritance tax on the net worth of their inheritance.
The net worth is the gross value less certain deductions, for instance a mortgage that must be paid off on an inherited house or a marital deduction for property inherited by a spouse.
If the result was more than the IRS exempt amount for a given year, for instance $1.45 million in 2009, the heir must pay an inheritance tax at the federal income tax rate for the non-exempt amount.
Heirs may have to pay property taxes as soon as they inherit real estate, and they will continue to pay them for as long as they own the house. Many states cap how much the assessed property value can rise from year to year, but when someone buys or inherits real estate, it will be reassessed at current market value.
Even if subsequent assessments are capped, the initial reassessment can result in heirs paying thousands of dollars more in taxes than the previous owner. Some states offer an exemption.
California state law, for instance, says that if the heir is the spouse or child of the owner, there is no reassessment. When an heir sells an inherited house, he has to pay capital gains tax on the profits.
The usual process for calculating capital gains is to subtract the market value of the home at the time it was inherited from the sale value. The heir can deduct costs such as the agent’s commission from the sale amount; if the adjusted value is less than the house was worth when it was inherited, the heir may be able to claim a tax loss.
Your basis for inherited property is usually the property’s value on the date of death for the person who bequeathed it to you. However, if the personal representative of the estate chose to use an alternative valuation date, your basis is the property value on that date.
The value of property, such as stocks or mutual funds, is the market price. For other types of property, the value is listed on the federal estate tax return or state inheritance tax schedule. An inherited asset you sell for more than the basis is taxed as a capital gain, including investments and personal property.
Taxable gains occur from selling stocks and bonds, as well as collections like stamps and coins. Even household furnishings are subject to capital gains tax.
Selling business property that you depreciated for tax purposes after inheritance triggers ordinary income tax, along with capital gains tax.
Do not report the loss from selling any personal property, such as household goods or an automobile.
Losses on these types of property are not deductible against gains from selling other property.
You also do not deduct the loss from the sale of a house, unless you rented it. No deduction is granted for a loss from the sale of a house used as your personal residence.
They say where there is a will, there is a way. And if the will names you as the sole or partial beneficiary of a home upon the death of a relative or friend, you will need to adequately prepare for the financial and personal ramifications.
Being named as a beneficiary of real estate in a will can present challenges as well as rewards.
Unless you are the surviving spouse, in which case legal transfer of the property to you should occur relatively quickly, seamlessly and without tax penalties, receiving an inheritance can be a long and complicated process.
It could take several weeks for the executor of the estate and the courts to divide the deceased’s assets and property up, including the home.
Following the death, the executor will file the deceased’s will in probate court, where a judge will determine the validity of the will. If it is considered valid, all property and assets are distributed according to the terms of the will.
Once ownership of the home is transferred to you, the government may deduct federal, state, and/or local taxes from the estate if its taxable net worth is more than a certain amount.
Inheritance tax is imposed on the transfer of assets, including real estate, at death. The rate depends on the relationship between the descendent and the inheritor.
Estate taxes, meanwhile, are imposed on the value of the property at death. The Federal government currently has an estate tax on estates worth more than $2 million dollars.
Some states have an estate tax, some have an inheritance tax, and some, like Maryland, have both.
To further understand the difference between the two, an inheritance tax is an assessment made on the portion of an estate received by an individual.
Eleven states still collect an inheritance tax including Connecticut, Indiana, Iowa, Kansas, Kentucky, Maryland, Nebraska, New Jersey, Oregon, Pennsylvania, and Tennessee.
An inheritance tax is different from an estate tax, which is a tax levied on an entire estate before it is distributed to individuals.
If you were to inherit a home worth, say $3 million, the federal estate tax would be $450,000.
If you decide to sell the inherited home, you will probably be required to pay capital gains tax on the difference between what you net from the sale and your basis, which is the purchase price plus improvements minus depreciation.
Currently, the federal capital gains tax is 15%. If the property is a personal residence and you meet certain guidelines, you can be exempted from capital gains tax on the first $250,000 if single or $500,000 if married.
Inherited property is taxed on the value of the property the day the owner died. It is easier to sell the home after death because you get a new basis, the value on the date of death, and, therefore, less capital gains tax.
However, some end up having to sell the home to pay the estate taxes due. If it is one parcel of land worth $10 million, for instance, and there are no other assets, then you may have to sell the land to get the cash to pay the $3.6 million in federal estate taxes, due within nine months of death.
After a property is inherited, it should be appraised to determine its fair market value at the time of death.
This is meant to establish a new tax basis for the property if it is eventually sold. If you have decided to sell the inherited home, you will need to determine a price and terms to sell the property.
You will also likely hire a real-estate broker as well as various consultants, including an appraiser, surveyor, real estate lawyer, accountant, and environmental consultant.
A mistake people often make is that a family member offered a relative $5 million for the property, and the relative turns the offer down, so it has to be worth more than that.
When someone is not willing to sell a property, a buyer may throw out a ridiculous number in a conversation, but that does not mean it is worth that or would sell for that. You have to value property based on deals that have closed or actual value.