For example, years ago, Sally`s parents bought a house for $100,000 and bequeathed the estate to Sally when they died. If Sally inherits the property, it is now worth $200,000. Here are some scenarios of how much profit from the sale of the home would be subject to capital gains tax: Another option is a 1031 exchange, often referred to as a tax-deferred exchange. If you want to keep an inherited property as an investment/rental and sell it later, you can defer taxes, but include the profit in the purchase of a similar property (i.e. another investment property). Taxes would not be due until you sell this new property. Of course, it could also be postponed again by completing another 1031 exchange. The procedure for calculating capital gains on inherited property is given below: To calculate the capital gains tax payable, start with the tax base (sometimes called the cost base) of the inherited property. This is the initial purchase price of an asset plus any improvement. Fortunately, if you inherit property, this amount will be “increased”.
This means that the tax base is increased to its fair market value from the death of the owner. If property is obtained by inheritance or gift, it is not taxable to the beneficiary. If the heir or beneficiary of this gift of real estate sells it, the capital gains of the sale are taxable to the heir. Inheriting property can trigger a capital gains tax if you decide to sell it. And there are other taxes you may need to consider, for example: state inheritance tax. If the inherited property is a residence, you should live there for a few years before selling it. Alternatively, you can rent it. Talking to an estate planning lawyer or tax professional can be helpful if you`re inheriting assets from your parents or someone else and are worried about Uncle Sam. Step 6: Subtract the cost of the capital gain from the sale price of the property to know the net profit of the transaction. Under the new law, passed by Congress in 2015, an accuracy penalty may apply if a person who reports the sale of certain inherited real estate uses a basis higher than the final value of that property for federal discount tax purposes. Review what`s new – inheritance and gift tax to get updates on the final rules that will be adopted to implement the new law.
Reporting the sale on Schedule D (Form 1040), Capital Gains and Losses, and on Form 8949, Sales and Other Disposals of Capital Assets: The complicated part is calculating the tax base. It starts with the purchase price plus the cost of improvements, minus depreciation and selling costs and various other factors. Fortunately, calculating inherited properties is easier. Step 1: You need to know the acquisition and indexation costs in order to calculate the capital gains. Step 2: Cost of ownership – The property did not cost the heir anything, but for the calculation of the capital gain, the cost to the previous owner is considered the cost of acquiring the property. Step 3: Cost Indexation – The year of acquisition of the former owner is taken into account for the purpose of indexing the acquisition cost with the year of sale of the property. Step 4: The base year for these calculations has been updated from 1981 to 2001. Step 5: Calculate the cost of capital gains using the Acquisition Cost formula x (Sales Year Cost Inflation Index / Acquisition Year Cost Inflation Index), with the Cost Inflation Index (CII) varying each fiscal year and some of which are listed in table form below: Tax exemption is allowed for principal residences. If you live in the house for at least 2 of the last 5 years before the sale, you can qualify. The exempt amount is $250,000 in profits for individual taxpayers and $500,000 for married applicants. Using this exception can be useful if you have owned a property for a long time and it results in quite a profit.
For example, you may have inherited a property 10 years ago and the market value has increased by $300,000 since then. You could save between $66,000 and $96,000 in capital gains tax. To help you get the most out of your inheritance, we`ll walk you through how to calculate capital gains tax on inherited property, strategies to reduce or avoid tax, and how to report the sale on your tax return. .