How much will capital gains taxes on inherited properties cost me?

An inheritance is a windfall that can definitely help someone’s financial situation, but it can make your taxes a pain. If you inherit property or assets, as opposed to cash, you generally don’t owe taxes until you sell those assets. These capital gains taxes are then calculated on what is known as a tiered cost basis. This means you only pay tax on capital gains that occur after you inherit the property. A financial advisor can ensure that you file your returns correctly. Let’s take a look at how capital gains are taxed on inherited property.

If you inherit real estate, you do not automatically pay taxes

There are three main types of taxes related to inheritance:

  • Inheritance tax – These are taxes that an heir pays on the value of an estate they inherit. There are no federal estate taxes and only six states levy any kind of estate tax. Given the state-specific nature of estate taxes, this topic is beyond the scope of this article.

  • Wealth tax – These are taxes paid from the estate itself before anyone inherits from it. The inheritance tax has a minimum threshold. In 2021, that threshold was $11.7 million. As with all other tax brackets, the government will only tax the amount that exceeds this minimum threshold, meaning that if your estate is worth $11,700,001, the government will tax $1. The remainder will pass tax-free.

  • Capital gains taxes – These are taxes paid on the increase in value of assets inherited by an heir through an estate. They are levied only when you sell the assets for a profit, not when you inherit.

Money you inherit is taxed through estate tax (if applicable) or through estate tax. In the case of estate tax, it is your responsibility to file and pay this tax. In the case of estate taxes, the IRS taxes the estate directly. As a result, it is unusual for an heir to owe taxes, including income tax, on inherited cash.

The IRS does not automatically tax other forms of property you could inherit. This means that if you inherit real estate, stocks, or any other form of asset, you will generally not owe any taxes when you inherit. For example, if you inherit your grandparents’ house, the IRS will not tax you on the value of the property when you receive it. (There are exceptions to this rule in certain specific circumstances. Typically, these exceptions apply to assets that generate income, such as income investments, retirement accounts, or current affairs.)

However, you will owe capital gains tax if you choose to sell this property.

Capital gains are taxed on a graduated basis

When you inherit property, be it real estate, securities, or almost anything else, the IRS applies what’s known as an elevated basis to that asset. This means that for tax purposes, the asset’s base price will reset to its value on the day you inherited it. If you inherit property and then immediately sell it, you will not owe any taxes on those assets.

Capital gains tax is paid when you sell an asset. They are levied only on the profit (if any) you make from this sale. Say you buy a stock for $10. Later you sell that same stock for $50. You owe capital gains tax on the $40 you earned from this transaction.

There are two prices involved in determining a capital gains tax: the selling price (how much you sold the asset for) and the original cost basis (how much you bought it for). In our example, the selling price of this stock is $50 and the original cost basis is $10. You are taxed on the difference, which again brings us to $40 in taxable income.

Now consider the scenario that your grandparents bought their house for $100,000 years ago. Today it has increased in value and is worth $500,000. If they sold the house, they would pay capital gains tax on $400,000:

  • Sale Price ($500,000) – Original Cost Basis ($100,000) = $400,000

However, instead they die and pass the house to you. At the time you inherit, the IRS will raise the home’s original cost basis to its current market value. This means that if you sell it immediately, you will not pay any capital gains tax:

On the other hand, suppose you hold the house for a year, during which time the price of this house increases by $100,000. If you sell it, you only owe capital gains tax on $100,000:

  • Sale Price ($600,000) – Accrued Original Cost Basis ($500,000) = $100,000 Taxable Capital Gains

The increased cost base means that it is relatively rare for heirs to pay significant taxes on an amount of inheritance.

It comes down to

There are some ways to avoid paying capital gains tax on inherited property that are worth considering if you are the beneficiary of an estate or trust. When you inherit real estate, the IRS applies what is called an accrual cost basis. You do not automatically pay tax on real estate that you inherit. If you sell, you only owe capital gains tax on any gains the asset has made since you inherited it.

Tips on taxes

  • Capital gains can be one of the most complicated parts of tax law. Fortunately, a financial advisor can clarify how best to deal with these situations. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor, get started now.

  • Use a free federal income tax calculator to get a quick estimate of what you owe “Uncle Sam.”

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