Do You Have to Pay Taxes on Inherited Property?

It is not certain that you will owe significant taxes on inherited property, but it is crucial to understand the potential tax liabilities associated with inherited assets. There are three main types of taxes that may apply to inheritances:

• Inheritance Taxes: These are taxes an heir pays on the value of the estate they inherit. There are no federal inheritance taxes, and only six states impose any form of inheritance tax.
• Estate Taxes: These are deducted from the estate itself before distribution to the heirs. The estate tax has a minimum threshold; in 2024, it is $13.61 million for individuals or $27.22 million for married couples. The government only taxes the amount exceeding this threshold. For instance, if the taxable estate is worth $13,610,001 in 2024, taxes will be levied on just $1, while the rest passes tax-free.
• Capital Gains Taxes: These are taxes on the appreciation of assets inherited through an estate. They are only applied when the assets are sold for a gain, not when they are inherited.

Inherited cash may be subject to either inheritance taxes or estate taxes. Inheritance taxes, where applicable, must be filed and paid by the heir. In contrast, estate taxes are levied directly on the estate by the IRS before distribution. Consequently, it is uncommon for heirs to owe any additional taxes, including income tax, on inherited cash.

The IRS does not automatically impose taxes on other types of property you might inherit. If you inherit property, stocks, or other assets, you may not owe taxes upon inheritance. For instance, if you inherit your grandparents’ house, the IRS will not tax you on the property’s value at the time you receive it.

There are exceptions to this rule in specific circumstances, particularly for assets that generate revenue. This includes income investments, retirement accounts, or ongoing businesses, which may be subject to taxation.

However, if you choose to sell the inherited property, you will be subject to capital gains taxes.

Capital Gains Taxed Using a Stepped-Up Basis

When you inherit property, whether it is real estate, securities, or other assets, the IRS applies a stepped-up basis to that asset.

For tax purposes, this means the base price of the asset is reset to its value on the day you inherited it. Consequently, if you inherit property and then immediately sell it, you would likely owe no taxes on those assets.

The rules apply equally whether you jointly own the property or not. For jointly owned inherited property, the capital gains tax is evenly divided among the owners based on their respective ownership stakes.

Capital gains taxes are paid when you sell an asset and are applied only to the profits from the sale. For example, if you purchase a stock for $10 and later sell it for $50, you will owe capital gains taxes on the $40 profit from this transaction.

Two prices are used to determine capital gains tax: the sale price (the amount for which you sold the asset) and the original cost basis (the amount you initially paid for it). In the given example, the stock’s sale price is $50, and the original cost basis is $10. You are taxed on the difference, which amounts to $40 in taxable income.

Consider a hypothetical scenario where your grandparents purchased their house years ago for $50,000. The property’s value has since increased significantly to $800,000. If your grandparents were to sell the house, they would potentially owe capital gains taxes on the $750,000 profit.

●     Sale price ($800K) – Original cost basis ($50K) = $750K

However, if your grandparents pass away and you inherit the house, the IRS will adjust the house’s original cost basis to its current market value at the time of inheritance. This stepped-up basis means that if you sell the house immediately, you will not owe any capital gains taxes.

●     Sale price ($800K) – Stepped-up original cost basis ($800K) = $0 taxable capital gains

Conversely, if you hold the house for a year and its value increases by another $100,000, you would owe capital gains taxes only on that $100,000 profit when you sell it.

●     Sale price ($900K) – Stepped-up original cost basis ($800K) = $100K taxable capital gains

The stepped-up cost basis, which adjusts the asset’s value to its market value at the time of inheritance, generally minimizes the tax burden on heirs. By being aware of these tax implications and the circumstances in which they apply, heirs can better manage their inherited assets and potential tax obligations.   www.pharrcpa.com