Do you pay taxes on inherited property?

Do you pay taxes on inherited property? The short answer

There are four different taxes people mean when they ask this question, and they work very differently. Income tax on the inheritance itself: generally no. Federal estate tax: only on very large estates, and the estate pays it, not the heirs. State estate or inheritance taxes: only in a small number of states. Capital gains tax: possibly, but only when you sell, and only on the gain above your stepped-up basis.

Separately, ongoing property taxes keep coming due every year you own the house, just as they did for the person who passed away. Those aren't optional, and falling behind on them can eventually put the house at risk.

Most heirs who sell within a reasonable time after the death find that the tax bill is smaller than they feared. The bigger financial risk is often the cost of holding the house: taxes, insurance, utilities and repairs on a property nobody lives in. Keep that in mind when you weigh the taxes on inherited property against the carrying costs of waiting.

Inheriting a house isn't taxable income

The IRS treats an inheritance as something other than income. You don't report the value of an inherited house on your federal income tax return in the year you receive it. That's true whether the house is worth a little or a lot.

What can be taxable is income the house produces after you inherit it. If you rent it out, the rent is income. If you sell it for more than your basis, the gain is income. Those are the taxes on inherited property that most heirs actually need to plan for.

Estate and inheritance taxes on inherited property: who pays

The federal estate tax is charged to the estate of the person who died, before property passes to heirs. It applies only when the estate's total value is above a high exemption amount set by law, so most estates owe nothing. The executor handles any filing.

There's no federal inheritance tax. A small number of states charge their own inheritance tax, which is paid by the person who receives the property, and some states have their own estate tax with lower thresholds than the federal one. In states with an inheritance tax, the rate often depends on your relationship to the person who died, and spouses are commonly exempt. Check your state's revenue department or ask a tax professional, and look at the state where the property is and the state where the owner lived.

Capital gains taxes on inherited property and the stepped-up basis

When you sell, you pay capital gains tax only on your gain: the sale price, minus selling costs, minus your basis. For inherited property, your basis is generally the fair market value on the date of death, not what the original owner paid. This is called a stepped-up basis, and it erases the gain that built up during the owner's lifetime.

Say a parent bought a house decades ago for far less than it's worth today. If you inherit it and sell it soon afterward for about its date-of-death value, your taxable gain may be close to zero. If you hold it for years and it rises in value, you'd owe tax only on the increase after the date of death.

Gain on inherited property is generally treated as long-term, no matter how long you held it, which usually means lower federal rates than ordinary income. In some cases the estate may elect a different valuation date, which changes the basis, so check with the executor.

How much tax on an inherited house: working it out

You can estimate your own numbers with a few figures. A tax professional can confirm them, but this is the basic order of operations for figuring capital gains taxes on inherited property.

• Start with your basis: usually the appraised value on the date of death
• Add the cost of improvements you made after inheriting, like a new roof (not routine repairs)
• Take the sale price and subtract selling costs you paid, such as commission and closing costs
• The difference between the two is your gain or loss
• Long-term rates apply to most gains on inherited property, and your income level sets the rate

Capital gains on property inherited with siblings

When siblings inherit a house together, each one generally takes a share of the stepped-up basis that matches their ownership share. If three siblings each inherit a third, each has a third of the basis and reports a third of the gain or loss when the house sells.

Things change if one sibling buys out the others. The buyer's basis in the shares they purchase is what they paid for them, and the selling siblings may have their own gain or loss to report. If the estate itself sells the house before distributing it, the estate may need to file its own income tax return and report the sale there instead. Your executor and tax professional can tell you which applies.

When the estate pays the taxes on inherited property instead of the heirs, the executor is responsible. Estates that have income above a low threshold generally file their own income tax return, and the gain or loss from the sale flows through that return. The executor should keep the closing statement and talk with the estate's tax preparer before distributing the proceeds, so money is set aside for any tax the estate owes.

Other taxes on inherited property while you own it

Property taxes continue. In some states, a transfer at death can trigger a reassessment that raises the tax bill, while others allow exemptions for certain family transfers. If the owner had a homestead or senior exemption, it usually ends with their death, so the next bill may be higher.

If you rent the house, rental income is taxable and you'll generally be able to deduct expenses and depreciation. Depreciation lowers taxes now but can increase the tax due when you sell. If you move in and make it your main home, the home-sale exclusion may eventually apply after you meet the ownership and use tests. Each choice changes the taxes on inherited property later, so it's worth deciding with a professional.

Selling an inherited house at a loss

Sometimes an inherited house sells for less than its date-of-death value, especially if it needs repairs or the market softened. Because your basis is the stepped-up value, the sale can produce a loss on paper. Whether you can deduct it depends on how you used the house. A loss on a home you used personally generally isn't deductible, but a loss on inherited property you held for sale or investment and never used personally may be. This is a good question for a tax professional before you file.

A loss also highlights why the date-of-death appraisal matters. A credible, well-documented appraisal supports your basis whether the sale produces a gain or a loss, and it protects all the heirs if questions come up later.

Records to keep for taxes on inherited property

Good records make the tax side simple. Keep these together, and keep them for several years after you sell.

• The date-of-death appraisal, or the value the estate reported
• The death certificate and documents showing how the house passed to you
• Receipts for improvements you made after inheriting
• The closing statement from the sale, showing price and selling costs
• Any property tax bills and estate tax filings related to the house

Selling an inherited house with Prominent

Prominent Cash Offer buys inherited houses directly, as-is, in any condition. If the property is a fit, you'll get a written cash offer with the amount and terms spelled out, which also gives you and your tax professional a clear sale price to work with. There are no fees or commissions, we pay the closing costs, and you choose the closing date, including one after the estate's paperwork is in order. There's no obligation to accept.