Inheriting a home when a loved one passes away can cause stress and confusion. Depending on probate, the process through which a deceased person’s estate gets distributed, you could be in for a long process full of new legal terms and potential hoops to jump through. This happens while you’re mourning the loss of a relative or close friend. It isn’t easy. But with the help of a legal professional to get you through the jargon, and a little background knowledge on tax implications, you’ll make it through the process just fine and come out on the other side as a property owner.
There’s nothing more frustrating than learning you’re inheriting property, only to get immediately slapped with taxes to pay. Should this happen, you’re most likely paying out an inheritance tax. This tax gets calculated separately for each person who inherits either money or physical items from an estate. Typically the total value of the inheritance must reach a minimum amount before you have to start paying an inheritance tax. This number can be rather large, so if your inheritance falls under this cap, you won’t have to pay anything. For example, if the state you live in charges a five percent tax on inheritances over $3 million, but the house you inherit is only valued at $450,000, you will not have to pay the inheritance tax.
Your relationship to the deceased may also give you the right to a tax exemption or reduction in the amount of inheritance tax you’re required to pay. When it comes to inheriting property, often spouses are exempt from tax. In some cases, children and other dependents can qualify as well. People who inherit property from someone they have no familial connection to often pay at or near the high end of the inheritance tax rate.
The differences between federal and state
Luckily, at the federal level, the IRS is only concerned with capital gains, which you may earn from selling an inherited home. The federal government does not have an inheritance tax, and it’s uncommon to pay income tax on a home you inherit since it’s not considered part of your annual income. Inheritance tax comes solely from the policies of the state.
Because only certain states have an inheritance tax, it’s important to consult with a local tax attorney or an estate lawyer when you inherit anything from a deceased relative. Make sure they’re aware of the tax laws in the state the house is in, since that determines the inheritance tax you’ll have to pay.
As of 2019, only six states require you to pay an inheritance tax. They are:
- New Jersey
Even within these states’ rules, exception amounts and rates vary. There’s no way to know what you’re liable to pay in inheritance tax without doing a little research.
This is another complicated tax you should know about when you inherit a house, even though you’re not responsible for paying it. An estate tax, if it’s required, comes out of the money from the deceased’s estate. Before you inherit the property this tax must be paid. The executor (the person designated to handle all the requests in the will itself) will most likely handle payment.
Unlike an inheritance tax, the federal government imposes an estate tax. The U.S. government also has a tax exemption, which in 2020 is $11 million. This means an estate won’t have to pay this tax if the inherited property has a value that’s less than this very high number. IRS Form 706 lays out the details on who must file a federal estate tax and how to calculate the amount owed, which can reach up to 40% of the estate value.
States can also impose an estate tax, and their rates and exemptions vary. You won’t have to work with a legal expert in the case of state level estate taxes because payment happens before you inherit the house. But knowing whether the home is in a state that has the tax will give you a better idea of what needs to happen before you gain ownership of the property. There are currently 12 states, plus the District of Columbia, that have an estate tax, but this is always subject to change with legislation.
According to Janelle Cammenga from Tax Foundation, “Most states have been moving away from estate or inheritance taxes or have raised their exemption levels, as estate taxes without the federal exemption hurt a state’s competitiveness.”
Read more: The Sundae Guide to Inheriting a House
Taxes when selling an inherited home
Once you’ve done everything necessary to gain ownership of your inherited home, whether it’s paying taxes or ensuring the deed is in your name, it’s time for another decision. To stay or go? If you decide to keep the home, the paperwork can stop here. You can redecorate, remodel, or simply move in and live on the property. However, if you decide to sell you may be responsible for another tax liability known as capital gains tax.
Capital gains tax is imposed anytime you purchase a “capital asset” and sell it for more than the original price you paid to purchase it. A capital asset is defined as stocks, bonds, jewelry, coin collections, and real estate property. You are responsible for paying capital gains tax when you sell a property.
The amount of the tax is based on how much money you’ve earned from the value of the home increasing. Thankfully, it’s not derived from the increased value between when the home was purchased by the deceased and its value when you sell it. Rather, the increase falls under a stepped-up cost, where the gain comes from the value of the home at the time of the owner’s death compared with when you sell the home.
For example, say the home you inherited had a value of $250,000 when the deceased passed. Eight months later, you decide to sell and get $251,000 for it. You end up with $1,000 more than then the home’s assessed value, so for income tax purposes your gain is only $1,000. You will need to report this amount on your income taxes for the year. Note: IRS rules on this subject have been changing in recent years, so remember to check the IRS website for current details.
Prepare for more than just the keys
When you inherit a home, it’s often more than just getting the keys from the executor. Whether there are delays in probate or issues with paying estate taxes, every step of the way can have hurdles. Especially when it comes to the specifics of paying the right taxes, it’s best to consult with a tax attorney to ensure you don’t get into any trouble down the road.
If you have general questions about how to handle inheriting a home, and what to do should you like to sell the property, Sundae is here to help. From figuring out how to handle repairs to get the property ready for market, or even starting the process to sell it as-is, we’re here to answer your questions and get things started.
Contact Sundae today to learn more.
Andrew is an experienced executive with expertise in finance and marketplaces. Prior to founding Sundae, Andrew was CFO at LendingHome, an online mortgage bank and prior to that, Andrew served as CFO at Airbnb. He also held leadership roles at Intuit and The Boston Consulting Group. Andrew holds an MBA from Harvard Business School.