How Do I Avoid Capital Gains Tax on Inherited Property

Selling inherited property typically triggers capital gains tax, but there are strategies to minimize or avoid it. One option is the step-up in basis rule, which allows you to adjust the property’s value to its market value at the date of inheritance. This lowers your taxable gain. Secondly, consider holding the property for over a year to qualify for the lower long-term capital gains rate. Additionally, if you inherit a primary residence and live in it as your main home for at least two of the past five years, you may be eligible for up to $250,000 in tax-free gain when you sell. For non-primary residences, you can exclude up to $500,000 in gain if you meet specific requirements. Consulting with a tax professional is recommended to explore all the available options and determine the best strategy for your specific situation.

Step-Up in Basis

When you inherit property, its tax basis is generally adjusted (or “stepped up”) to its fair market value at the time of the decedent’s death. This means that if you sell the property later, you will not pay capital gains tax on the appreciation that occurred before you inherited it.

Benefits of Step-Up in Basis

  • Avoids capital gains tax on inherited property
  • Reduces the amount of tax you pay if you sell the property
  • Potentially increases the value of your estate

To qualify for the step-up in basis, the property must have been acquired from a deceased person. It does not apply to property acquired by gift or sale.

Exceptions to Step-Up in Basis

There are some exceptions to the step-up in basis rule. These include:

ExceptionDescription
Property acquired from a trustProperty acquired from a trust may not receive a step-up in basis.
Property acquired by a surviving spouseProperty acquired by a surviving spouse may not receive a step-up in basis if it was held jointly with the deceased spouse.
Property acquired by a charityProperty acquired by a charity does not receive a step-up in basis.

If you are not sure whether the step-up in basis applies to your inherited property, you should consult with a tax professional.

Section 1031 Exchange

A Section 1031 exchange is a tax-deferred exchange that allows you to sell a property and reinvest the proceeds in a like-kind property without paying capital gains tax. This can be a valuable tool for investors who want to avoid paying taxes on the appreciation of their property.

  • To qualify for a 1031 exchange, the following requirements must be met:
    • The property being sold must be held for investment or business purposes.
    • The property being purchased must be of like-kind.
    • The proceeds from the sale of the property must be reinvested in the new property within 180 days.
    • The taxpayer must not receive any cash or other property in the exchange.

    If all of the requirements are met, the taxpayer will not have to pay capital gains tax on the sale of the property. Instead, the basis of the new property will be the same as the basis of the old property, and the taxpayer will continue to defer paying taxes on the appreciation of the property until it is sold.

    Section 1031 exchanges can be a complex process, so it is important to consult with a qualified tax advisor before completing one. However, if done correctly, a 1031 exchange can be a valuable tool for investors who want to avoid paying capital gains tax on the sale of their property.

    Charitable Donation

    You can avoid capital gains tax on inherited property by donating it to a qualified charity. This is a great option if you don’t plan on selling the property or if you don’t think you can get a good price for it. When you donate property to a charity, you can deduct the fair market value of the property from your income taxes. This can save you a significant amount of money, especially if you have a high income.

    There are a few things to keep in mind when donating property to charity. First, you need to make sure that the charity is a qualified charity. Not all charities are eligible to receive property donations. You can check the IRS website to see if a charity is qualified.

    Second, you need to get an appraisal of the property. This will help you determine the fair market value of the property. The appraisal should be done by a qualified appraiser.

    Once you have the appraisal, you can complete the donation process. You will need to fill out a donation form and provide the charity with a copy of the appraisal. The charity will then issue you a receipt for the donation.

    You can deduct the fair market value of the property from your income taxes when you file your taxes. You will need to attach a copy of the receipt from the charity to your tax return.

    BenefitDrawback
    You can avoid capital gains tax on the property.You will not receive any money for the property.
    You can deduct the fair market value of the property from your income taxes.You may need to pay for an appraisal of the property.
    You can support a worthy cause.The charity may not be able to use the property for its intended purpose.

    Deferred Payment Sale

    In a deferred payment sale, the heir does not receive the full amount of the property’s value at the time of inheritance. Instead, they receive payments over time, with no interest charged. The capital gains tax is then paid as each payment is received.

    This can be a good option if the heir does not have the cash on hand to pay the capital gains tax upfront. However, it is important to note that the heir will still be responsible for paying the tax on the full amount of the property’s value, even if they do not receive the full amount of the proceeds from the sale.

    There are a few things to keep in mind when considering a deferred payment sale:

    • The heir will need to find a buyer who is willing to agree to the terms of the sale.
    • The heir will need to be able to make the payments on time.
    • The heir will need to pay the capital gains tax on the full amount of the property’s value, even if they do not receive the full amount of the proceeds from the sale.

    Whew! Navigating the complexities of capital gains tax on inherited property can be a bit of a rollercoaster, but hopefully this article has shed some light on the subject. Remember, the rules can vary depending on your unique circumstances, so it’s always best to consult a tax professional for personalized guidance. Thanks for reading, and we hope you’ll stick around for more informative and engaging content in the future. Cheers!