Key things to know about inheriting property

Whether you are thinking about your own estate plan or a potential inheritance you may receive from a loved one, there are some key things to know in order to plan properly for tax obligations.

When planning for the distribution of certain assets through your estate plan or when receiving an inheritance, it is important to understand how the basis of property is determined in different circumstances. In tax terms, the “basis” of an asset is the amount you paid for it, whether it be art, collectibles, stocks, bonds, mutual funds, or real estate.

In the case of real estate, you can add the cost of capital improvements made to a house to increase your basis. Capital improvements include adding an addition, upgrading or replacing HVAC or plumbing systems, and replacing a roof, among other things. When you sell your property, you will have capital gain if it is sold for more than the value of your basis. Depending on a variety of factors, you may owe capital gain taxes on that profit.

If you inherit property from a loved one, you get an adjusted basis, which means a basis in the property – whether it be a home, stock, art, or other assets[i] -- that is equal to the fair market value of the property at the time of your loved one’s death. For example, if you inherit your parent’s home that was originally purchased for $100,000 in 1980 but valued at $500,000 at the time of your parent’s death, your basis in the property will be $500,000. In situations where there has been an appreciation of the asset since its purchase, heirs will benefit from this stepped-up basis, which can substantially reduce or eliminate capital gains taxes when they sell the property.

An adjusted basis can also include a step-down, if the property is lower in value at the time of the decedent’s death than the purchase price. For example, if you inherit stock that was originally purchased for $100,000 by your loved one but has a value of $70,000 at the time of your loved one’s death, you will have a basis in the stock of $70,000.

Of course, the basis in whatever property you inherit can change after receiving it. If you make improvements to the asset, your basis will increase. These changes are similar to adjustments you would make if you had purchased the asset yourself.

Another concept that is important to know is carryover basis. When someone gifts property to another person during the gift giver’s lifetime, the gift recipient receives a carryover basis in the asset. This is the purchase price paid by the giver of the property. For example, if a parent purchased a home for $100,000 in 1980 and gives the home to their child during the parent’s lifetime when it is valued at $500,000, the child will have a basis of $100,000 in the property. The child then may have significant capital gains taxes when they decide to sell, since they must use the basis of their parent.

While there are many factors when considering how to properly plan for distributing or inheriting property, it is important to understand these basis concepts to make sure you are taking taxes into account when planning. Working with an estate planning attorney can help you navigate the best choices for you and your family. Schedule a consultation if you want to get started on your plan!

[i] It is important to note that inherited traditional IRA’s and retirement accounts do not receive an adjusted basis. Withdrawals are typically subject to ordinary income tax.