How to Avoid Paying Taxes on an Inherited Property
Inheriting a house or a Picasso is fantastic, unless a tax bill comes with it. If you decide you want to sell your inheritance, profits on the sale are taxable. If you keep the property, you may have other taxes, such as property tax on a house. Some states even charge an inheritance tax. There are ways to minimize the tax bite, though.
Avoiding Tax on Inherited Property
When you sell property you bought yourself, the taxable gain is the difference between the basis or purchase price and the sales price. When you inherit, it doesn't matter what the original purchase price was: your basis is the fair market value on the day the former owner died. If you inherit a $200,000 painting, say, and sell it immediately, it won't have time to rise in value. If it sells for $200,000, none of that is taxable income.
The federal government offers a great tax break when you sell your own home. If you've owned the house and lived there for two of the five years before the sale, you can exclude $250,000 of gain on the sale from taxes. On a joint return, you can take $500,000 if you and your spouse both live there. If you inherit a house and don't want to sell until the market picks up, moving in can protect you from tax on any profits when you finally unload it.
Some taxes aren't as easy to duck as capital gains tax on inherited real estate. For example, if you inherit a house, you owe property tax on the property for as long as you own it. This is not avoidable, regardless of how you acquire the property. Six states impose inheritance taxes, which hit you if you live there, if the deceased lived there or if you inherit real estate there. Your relationship may protect you – spouses don't pay inheritance tax, for instance, and certain close relatives typically pay less than other people – but if you inherit property and the inheritance tax applies, you must pay it.
Exceptions for Disclaimed Inheritances
One way to avoid tax completely is to never inherit at all. If you do this, you're said to "disclaim" your inheritance. You file a written statement with the estate executor saying you don't want the property and it passes to the next heir in line. Legally, you've never owned it, so there's no tax bill for you. You have nine months after the death to do this, and you can't have benefited from any proceeds on the property. It also can't be eligible to be directly passed to you once you disclaim it.
2018 Tax Brackets and Exclusions
The Tax Cuts and Jobs Act brings some changes that will affect any long-term capital gains starting in 2018. The 15 percent tax bracket starts at $38,601 for single filers, with single filers making $425,801 or more falling in the 20 percent brackets. Moving forward, those brackets will be adjusted for inflation. However, there's good news in the way of income tax on your gains. A deceased taxpayer can leave up to $11.2 million to loved ones without paying taxes, assuming that taxpayer hasn't taken advantage of the annual gift exclusion, which counts toward that amount. This exclusion is per person, so a married couple can gift double that amount over the course of a lifetime without tax repercussions.
2017 Returns and Capital Gains Tax
If you owe long-term capital gains tax on inherited property, you'll enjoy 0 percent tax on dividends that fell within the 10 percent or 15 percent income brackets. Those brackets changed under the TCJA.
References
- Nolo: Inheritance Tax
- Nolo: Disclaiming a Gift or Inheritance
- IRS: Topic Number 701 - Sale of Your Home
- Tax Foundation: Does Your State Have an Estate or Inheritance Tax?
- DISAVOW | definition in the Cambridge English Dictionary
- MarketWatch: Your simple guide to the new capital gains tax rates
- NerdWallet: I Like Being Generous, but Do I Have to Pay a Gift Tax?
Resources
Writer Bio
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.