nheriting a home or other property can increase the value of your estate, but it can also For more information result in tax consequences. If the property you inherit has appreciated in value since the original owner purchased it, you could be on the hook for capital gains tax should you choose to sell it. That could result in a large tax bill if there’s a sizable gap between the original purchase price and the price you’re able to sell the property for. Here are some possibilities for how to avoid paying capital gains tax on inherited property, which are worth considering if you’re the beneficiary of an estate or trust.
Understanding the Capital Gains Tax
Capital gains tax applies when an investment is sold for more than its original purchase price. Typically, you might think about capital gains tax in terms of selling stocks or other securities you hold inside your investment portfolio. So if you bought a stock for $2 per share and sold it for $5 per share, you’d owe capital gains on the $3 in profit you realized from the sale.
Capital gains are taxed differently, depending on how long you hold the underlying asset. The short-term capital gains tax rate applies to investments or assets that are held for less than one year. The long-term capital gains tax rate applies to investments or assets that are held for more than one year. Capital gains tax generally applies when you sell an investment or asset for more than what you paid for it.
2024 Short-Term Capital Gains Tax Rates
Short-term capital gains are taxed as ordinary income. For tax year 2024, which you will file in 2025, the maximum you could pay for short-term capital gains is 37%. The table below breaks down the 2024 federal income tax bracket for your short-term capital gains, with the 2023 bracket to follow for comparison:
Especially if you’re in a higher tax bracket, it typically makes more sense to hold investments longer to minimize the amount of capital gains tax you owe. Note that some states may also charge their own capital gains taxes. You should also keep in mind that the top capital gains tax rate may get raised in the future due to changes on Capitol Hill.
Capital Gains Tax Rules for Inherited Property
When inheriting property, such as a home or other real estate, the capital gains tax kicks in if you sell that asset at a higher price point than the person you inherited it from paid for it. Likewise, it’s possible to claim a capital loss deduction if you end up selling the property at a loss.
The difference with inherited property, however, is that the IRS allows you to use what’s known as a stepped-up basis for calculating capital gains tax liability. The step-up cost basis represents the value of the home when you inherit it versus its original purchase price.
For example, say your parents bought a home for $100,000 that’s worth $400,000 by the time you inherit it. Under ordinary capital gains tax rules, you’d owe tax on the $300,000 difference between what your parents paid for it and its current value.
That could result in a huge tax bill, which is why the IRS allows you to use the stepped-up basis instead. Assume that you don’t sell the home right away, for instance. You hold on to the property for two years, at which time you sell it for $450,000. Taking the stepped-up basis of $400,000 into account, you’d only pay capital gains tax on the $50,000 in appreciation value.
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