When real estate is left to you in a will, the potential capital gains tax implications depend on a few key factors:
1. Step-Up in Basis
- Automatic Step-Up: In most cases, when you inherit real estate, you receive a “step-up” in basis. This means the property’s basis (its value for tax purposes) is adjusted to its fair market value (FMV) on the date of the decedent’s death.
- Impact on Capital Gains Tax: The step-up in basis generally eliminates or reduces the capital gains tax if you sell the property shortly after inheriting it. For example, if the property was worth $200,000 at the time of inheritance and you sell it for $200,000, there would typically be no capital gains tax because the basis was stepped up to the FMV.
2. Sale of the Property
- Selling After Inheritance: If you sell the inherited property and its value has increased since the date of death, you may be liable for capital gains tax on the appreciation that occurred after the inheritance. The gain is calculated as the sale price minus the stepped-up basis.
- Capital Gains Rates: The tax rate on capital gains depends on how long you hold the property before selling it and whether the gain is classified as short-term or long-term. Inherited property typically benefits from long-term capital gains rates, which are usually lower.
3. Property Use and Income
- Rental Income: If you choose to rent out the inherited property, any rental income you earn is subject to income tax. However, the property’s basis for capital gains tax purposes will be the stepped-up basis.
- Depreciation: If you depreciate the property while renting it out, the depreciation taken can affect the capital gains calculation when you eventually sell the property.
4. State Taxes
- State-Level Considerations: Some states have their own rules regarding capital gains taxes and may not conform to federal rules on the step-up in basis. It’s important to check state-specific laws and consult with a tax advisor to understand any additional state tax implications.
5. Exceptions and Special Rules
- Personal Residence Exclusion: If the inherited property is used as your primary residence and you meet certain requirements, you may qualify for a capital gains exclusion up to $250,000 for single filers or $500,000 for married couples filing jointly. However, this rule is more relevant for properties acquired through purchase rather than inheritance.
Summary:
Inheriting real estate generally provides a step-up in basis, which means you won’t owe capital gains tax on the appreciation that occurred before your inheritance. If you sell the property, you may owe capital gains tax on any increase in value that occurs after the inheritance. It’s essential to keep track of the property’s stepped-up basis and consult with a tax advisor or estate planning professional to understand how these rules apply to your specific situation and any potential state tax implications.