While inheritance itself is not considered taxable income, the sale of an inherited property can trigger capital gains tax liability.
Understanding the tax implications of selling an inherited property is crucial to minimize tax liability and ensure compliance with tax laws. In this article, we will explore the tax implications of selling an inherited property in the U.S.
Determining The Basis Of The Inherited Property
To determine if the sale of inherited property is taxable, you must first determine your basis in the property. The basis of property inherited from a decedent (the legal term for someone who has died) is generally one of the following:
- The Fair Market Value (FMV) of the property on the date of the decedent’s death (whether or not the executor of the estate files an estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return).
- The FMV of the property on the alternate valuation date, but only if the executor of the estate files an estate tax return (Form 706) and elects to use the alternate valuation on that return.
You would need to contact the executor of the decedent’s estate for more information of the FMV of the inherited property on the day of the decedent’s death.
Capital Gains Tax
The IRS considers the sale of an inherited property as a taxable event, and the gain from the sale is subject to capital gains tax. The gain is calculated by subtracting the basis (the original value of the property) from the sale price. If the sale price is higher than the basis, the difference is considered a capital gain, and it is taxable.
Step-Up in Basis
The basis of an inherited property is typically stepped up to the fair market value at the time of the original owner’s death. This means that the capital gain will be lower, and therefore the tax liability will be reduced. For example, if the original owner purchased the property for $100,000 and it was worth $500,000 at the time of their death, the basis would be stepped up to $500,000. If the property is sold for $600,000, the capital gain would be $100,000 ($600,000 – $500,000).
Primary Residence Exemption
If the inherited property is the seller’s primary residence, they may be eligible for an exemption from capital gains tax on up to $250,000 of gain ($500,000 for married couples). To qualify for this exemption, the seller must have lived in the property for at least two of the five years preceding the sale.
Charitable Donations
If the inherited property is donated to a qualified charity, the seller may be eligible for a tax deduction. The deduction is equal to the fair market value of the property at the time of the donation.
Instalment Sales
If the seller chooses to receive payment for the property in instalments over time, they may be able to spread out the capital gains tax liability over multiple years. This can help reduce the tax burden in any given year.
Like-Kind Exchanges
If the seller exchanges the inherited property for another property of equal or greater value, they may be able to defer capital gains tax liability. This is known as a like-kind exchange, and it can help sellers avoid paying capital gains tax on the gain from the sale of the inherited property.
State and Local Taxes
In addition to federal taxes, sellers should also consider state and local taxes on inherited property. Some states have their own estate or inheritance taxes, which may apply to the transfer of property. Others may have specific rules or exemptions for capital gains tax on inherited property.
Also note that, under the law passed by Congress in 2015, an accuracy-related penalty may apply if an individual reporting the sale of certain inherited property uses a basis in excess of that property’s final value for Federal estate tax purposes.
Is the Sale Of Property Taxable?
All in all, money received from the sale of an inherited property is considered taxable income in the U.S. However, there are exceptions and special situations to consider, such as the step-up in basis, primary residence exemption, charitable donations, instalment sales, and like-kind exchanges. By understanding the tax implications and seeking professional advice, sellers can navigate the process with confidence and minimize their tax liability. It’s essential to consult with a tax professional or financial advisor to ensure compliance with tax laws and optimize tax strategies.
