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Although inheritance taxes are rarely a worry in practice—only a small number of states impose them—heirs frequently worry excessively about them, so it’s likely that you won’t have to pay one. However, if you reside in a state where taxes are levied, the particulars of your inheritance situation may significantly alter your bill.
Inheriting a house can be a bittersweet experience. While you’re likely grieving the loss of a loved one, you’re also receiving a valuable asset that can provide financial security and stability. However, one question that may arise is whether you’ll have to pay inheritance tax on the house. The answer depends on several factors, including your location and relationship to the deceased.
What is Inheritance Tax?
Inheritance tax is a levy imposed by some states on the recipients of inherited assets. Unlike the federal estate tax, which is assessed on the estate itself, inheritance tax is paid by the beneficiary of the bequest. This means that the responsibility for paying the tax falls on the individual who receives the inheritance, not the estate of the deceased.
Which States Impose Inheritance Tax?
As of 2023, only six states in the U.S. impose an inheritance tax:
- Iowa
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
Who Pays Inheritance Tax?
Whether you’ll pay inheritance tax on a house left in a will depends on several factors:
- Your relationship to the deceased: Spouses and lineal descendants (children, grandchildren, great-grandchildren) are typically exempt from inheritance tax in all six states. Other beneficiaries, such as siblings, cousins, and unrelated individuals, may be subject to the tax.
- The value of the inheritance: Each state has its own exemption threshold for inheritance tax. If the value of the house you inherit exceeds this threshold, you may be liable for the tax.
- The state where the deceased resided or owned property: Inheritance tax is typically assessed by the state where the deceased lived or owned property.
How is Inheritance Tax Calculated?
Inheritance tax is typically calculated as a percentage of the value of the inheritance that exceeds the exemption threshold. The tax rates vary by state and can range from 2% to 18%.
How to Avoid Inheritance Tax on a House
There are a few strategies you can use to reduce or avoid paying inheritance tax on a house:
- Gift the property while you’re alive: If you’re considering leaving your house to a specific individual, you can avoid inheritance tax by gifting it to them while you’re still alive. However, there may be gift tax implications depending on the value of the property.
- Establish a trust: You can set up a trust to hold the house and distribute it to your beneficiaries after your death. This can help to reduce or avoid inheritance tax, depending on the type of trust you create.
- Move to a state without inheritance tax: If you live in one of the six states that impose inheritance tax, you may consider moving to a state that doesn’t have this tax.
Capital Gains Tax on Inherited Property
In addition to inheritance tax, you may also be subject to capital gains tax if you sell an inherited house for more than its fair market value at the time you inherited it. This is known as a “stepped-up basis.” For example, if your grandparents bought their house for $50,000 and left it to you in their will, and the house is now worth $800,000, you would only pay capital gains tax on the $750,000 increase in value.
While inheriting a house can be a significant financial benefit, it’s important to understand the potential tax implications. By understanding inheritance tax and capital gains tax, you can make informed decisions about how to manage your inheritance and minimize your tax liability. If you have any questions or concerns, it’s best to consult with a financial advisor or tax professional.
Frequently Asked Questions
Do I have to pay inheritance tax on a house left in a will if I live in a state that doesn’t have inheritance tax?
No, you will not have to pay inheritance tax on a house left in a will if you live in a state that doesn’t impose this tax. However, if the deceased resided or owned property in a state that does have inheritance tax, you may still be liable for the tax.
What happens if I can’t afford to pay inheritance tax?
If you can’t afford to pay inheritance tax, you may be able to work out a payment plan with the state or sell the house to cover the tax liability.
Can I deduct inheritance tax from my income taxes?
No, you cannot deduct inheritance tax from your income taxes.
Should I hire a lawyer or accountant to help me with inheritance tax?
If you have a complex estate or are unsure about your inheritance tax liability, it’s a good idea to consult with a lawyer or accountant who specializes in estate planning and taxation.
Additional Resources
Disclaimer: The information provided in this article is for general knowledge and informational purposes only, and does not constitute legal advice. It is essential to consult with a qualified legal or tax professional for advice tailored to your specific situation.
Inheritance tax definition
A tax on assets inherited from a deceased person, such as cash or a house, is known as an inheritance tax. The inheritor bears the tax liability, which varies according to the size of the inheritance and the inheritor’s relationship to the deceased.
Generally, tax bills and inheritance tax returns are due a few months after the decedent passes away.
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Inheritance taxes vs. estate taxes
Inheritance tax and estate tax are two different things. The beneficiary, or the individual who inherited the wealth, is required to pay inheritance tax when they receive it. On the other hand, estate tax is the sum deducted from a person’s estate depending on the estate’s value at death. When someone dies, one, both, or neither of them may be the cause.
Another significant distinction is that there is a federal estate tax even though there is no federal inheritance tax. The federal estate tax generally applies to assets over $13. 61% of the total in 2020–24, and the estate tax rate varies from 2018–400%. There are state-level estate taxes as well, and their exemption thresholds may be significantly lower than those of the IRS. Assets that spouses inherit generally arent subject to estate tax.
Due to the differences between the inheritance and estate taxes, some individuals may occasionally experience a double whammy. For instance, Maryland has both an inheritance tax and an estate tax, which means that the beneficiaries of an estate may have to pay the state again out of any remaining funds after the estate has paid the IRS and the state. However, this isnt the norm across the country.
» Organizing your estate? Understand the distinction between a trust and a will.