If you recently inherited a property and are debating whether to sell it or keep it, you should think about the potential for capital gains taxes to apply when you sell it. Thankfully, there are methods for avoiding having to pay taxes on assets that you inherit.
Receivers of inheritances may have certain capital gains tax-related concerns. You can sell the property right away for fair market value to avoid paying capital gains taxes. Recipients of inheritances may also choose to live on the inherited property full-time, avoiding the need to sell it and pay capital gains taxes. Another option is to decide to rent out the inherited property in order to make some money. Through the disclaimer of inherited properties or the deduction of closing costs from the sale of those properties, inheritance recipients can also avoid or minimize capital gains taxes.
For additional information regarding avoiding capital gains taxes on inherited property, give US Tax Help’s tax CPAs a call at (541) 362-9127.
Inheriting a house can be a bittersweet experience. While it’s a thoughtful gesture and a way to carry on your loved one’s legacy, it can also raise questions about potential tax implications. Understanding the tax rules surrounding inherited property can help you navigate this situation smoothly and make informed decisions.
Capital Gains Tax: The Key Consideration
The primary tax concern with inherited property involves capital gains tax. This tax applies when you sell an asset for more than its original purchase price. In the case of inherited property, the original purchase price is the value of the property at the time of inheritance, not what the original owner paid for it.
Here’s how it works:
- Scenario 1: Your parents bought a house for $100,000 and it’s worth $400,000 when you inherit it. If you sell it immediately, you’d owe capital gains tax on the $300,000 difference between the original purchase price and its current value.
- Scenario 2: You inherit the same house, but it’s worth $400,000 at the time. You hold onto it for two years and then sell it for $450,000. Thanks to the “stepped-up basis” rule, you’d only pay capital gains tax on the $50,000 appreciation value, not the entire $350,000 difference.
The stepped-up basis significantly reduces your capital gains tax liability, making inheriting property a financially advantageous event.
Avoiding Capital Gains Tax on Inherited Property
While the stepped-up basis offers significant relief, there are additional strategies you can employ to minimize or eliminate capital gains tax altogether:
- Sell the property immediately: By selling the property right away, you prevent further appreciation and potentially avoid capital gains tax altogether.
- Make it your primary residence: If you move into the inherited house and make it your primary residence for at least two years before selling it, you can exclude up to $250,000 (single filers) or $500,000 (married couples filing jointly) of the capital gains from taxation.
- 1031 exchange: If you rent out the inherited property, consider a 1031 exchange. This allows you to defer capital gains tax by reinvesting the proceeds from the sale into another investment property.
Other Taxes to Consider
While capital gains tax is the primary concern, there might be other taxes associated with inheriting property, depending on your location and the specific circumstances:
- Inheritance tax: Some states impose inheritance taxes on the value of the estate you inherit.
- Estate tax: This federal tax applies to estates exceeding a certain threshold. However, the threshold is currently set high enough that most estates won’t be subject to it.
- Property taxes: You’ll be responsible for paying ongoing property taxes on the inherited house.
Seeking Professional Guidance
Navigating the complexities of inherited property and its tax implications can be challenging. Consulting with a financial advisor or tax professional can provide valuable guidance and help you make informed decisions that minimize your tax burden.
Frequently Asked Questions
Do I have to pay taxes on a house I inherited if I don’t sell it?
No, you won’t owe capital gains tax if you don’t sell the inherited property. However, you’ll still be responsible for paying ongoing property taxes.
What happens if I inherit a house with a mortgage?
You’ll inherit the responsibility of paying off the remaining mortgage balance. You can choose to continue making payments, refinance the mortgage, or sell the house to cover the outstanding debt.
Can I disclaim an inheritance to avoid paying taxes?
Yes, you can choose to disclaim an inheritance, but this is an irreversible decision. The property will then pass on to the next person in line to inherit it.
How can I find a financial advisor to help with inherited property?
Online resources like SmartAsset can connect you with qualified financial advisors in your area. You can discuss your specific situation and receive personalized advice on managing your inherited property and minimizing your tax liability.
Inheriting a house can be a complex experience with potential tax implications. Understanding the rules surrounding capital gains tax, exploring strategies to minimize your tax burden, and seeking professional guidance can help you navigate this situation effectively and make informed decisions that protect your financial well-being.
How Can I Avoid Capital Gains Tax on Inherited Property?
You can avoid paying capital gains tax on an inherited property in four different ways. You have three options: sell it quickly, move in and use it as your primary home, rent it out to tenants, or give up the inherited possessions. By subtracting closing costs from the sale of inherited property, you may also be able to lower the capital gains.
Rent Out the Inherited Property
Hiring it out is another method of avoiding capital gains taxes on inherited property. This might enable you to keep the property and use it as a source of income. It’s possible for people to rent out inherited homes for years without having to sell them. By using a 1031 tax-deferred exchange, you can postpone paying capital gains taxes on the sale of an inherited property in the future and use the proceeds to purchase another rental property. You will be required to pay capital gains taxes on the sale of the rental property if you sell it and do not use the proceeds to buy another.