What Happens to Capital Gains Tax When You Sell an Inherited Property?
If you've inherited a property, selling it can be an emotional and complicated process. There are many things to consider, including the impact on your finances. One factor that's often overlooked is capital gains tax.
Capital gains tax is a tax on the profit you make from selling an asset, such as a property. In the case of inherited property, the tax is calculated based on the value of the property at the time of the previous owner's death. This is known as the "stepped-up basis."
To understand the stepped-up basis, let's take a closer look at how capital gains tax works. When you sell an asset, you're taxed on the difference between the sale price and the basis. The basis is the amount you paid for the asset, plus any improvements you've made over the years. For example, if you bought a property for $100,000 and spent $50,000 on renovations, your basis would be $150,000.
However, when you inherit a property, the basis is stepped up to the fair market value at the time of the previous owner's death. This means that if the property was worth $200,000 at the time of the previous owner's death, your basis would be $200,000. If you sell the property for $250,000, you would only be taxed on the $50,000 profit, rather than the $100,000 profit you would have been taxed on if you had sold the property for $250,000 before the previous owner's death.
It's important to note that the stepped-up basis only applies to assets that are inherited. If you receive a gift of property during the previous owner's lifetime, your basis is the same as the previous owner's basis. This means that if the previous owner bought the property for $100,000 and you sell it for $250,000, you would be taxed on the $150,000 profit.
Another factor to consider is the length of time that you've owned the property. If you sell the property within a year of inheriting it, your capital gains will be taxed at your ordinary income tax rate. However, if you hold the property for more than a year before selling it, you may be eligible for the lower long-term capital gains tax rate. This rate varies depending on your income level and can be as low as 0% for individuals in the lowest tax bracket.
There are also some exceptions and exclusions that may apply to inherited property. For example, if you sell a primary residence that you've inherited, you may be eligible for the $250,000 ($500,000 for married couples) exclusion on capital gains. This means that if the property was your primary residence for at least two of the five years before the sale, you can exclude up to $250,000 of capital gains from your taxable income.
In conclusion, selling an inherited property can have a significant impact on your tax bill. It's important to understand the stepped-up basis and how it affects your capital gains tax. Additionally, you should consider the length of time that you've owned the property and any exceptions or exclusions that may apply. To ensure that you're maximizing your tax savings, it's always a good idea to consult with a tax professional before making any major financial decisions.