Inherited Property and Taxes: What You Need to Know When Selling

Inheriting a property is always a bittersweet experience. On the one hand, it likely means that someone close to you has passed away, but on the other hand, you have gained something of substantial value. Even though your feelings may be running wild at this point, if you are thinking about selling it, you must consider any taxes you might be liable for, as well as how to go about the process. 

Depending on your jurisdiction, this will be easier or more challenging, but the tax man will always get his pound of flesh one way or another. However, several options are available to you regarding the process, which this article will discuss in more detail.

Can Inherited Property Be Sold?

The initial challenge is determining if you can sell an inherited property. Fortunately, the response to this initial query is a resounding yes. as long as the property has been fully transferred into your name and there are no outstanding legal issues that need to be resolved (e.g., liens, problems with succession, etc.). 

If you are uncertain about any aspect of the procedure or are simply looking for a quick sale, you might want to consider seeking out the services of a company that is able to offer cash upfront, which is often in a better position to deal with complex cases and provide you with the advice you need to expedite a sale. Additionally, if you opt to go the cash route, you must be 100% certain that the company you are dealing with is legitimate. For instance, this cash home buyer in Wilmington, North Carolina has an A+ rating from the Better Business Bureau and targets the Fayetteville market in North Carolina. In addition, they clearly state that they work with military personnel at Fort Bragg to ensure they are catered for. 

Make sure they can manage your inherited home under any circumstances when you use these services, including:

• Pre-foreclosure
• Probate
• houses with unfinished repairs
• Vacant houses
• Unwanted houses
• Divorce-related sales
• Expedited sales

What You Should Know About Inherited Property And Taxes Before Selling

Now that you are relatively au-fait about whether you can sell an acquired asset like a home, the question that inevitably pops up is, “What about the tax?” Taxes are a sticky issue at the best of times, but when you have been gifted something of such enormous value, it can become pretty scary pretty fast! You may also have questions like “what are the rules of a 1031 exchange?“, if you intend to sell the property and have already done some reading into your options. Consequently, before coming to any concrete solution to the question, you should update your knowledge of the various tax and inheritance laws.

The Probate Procedure For A Home

Even when things go smoothly, probate can be a complicated process. Usually, it involves giving the deceased person’s property and assets to the people who are supposed to get them (often family, but not always). If the deceased owned a home, the executor or administrator will need to take steps to make sure the house is well taken care of and safe while the probate process is going on. This may involve hiring a property manager or selling the home. 

Any outstanding debts and taxes owed by the decedent’s estate will be settled with the sale proceeds of the house if it is sold during the probate process (even if you use a cash service like mentioned previously, all outstanding debts will need to be paid before you receive any proceeds of the sale). Any remaining funds will be distributed to the heirs or beneficiaries according to the terms of the will or state law. It’s important to note that the probate process can be time-consuming and expensive, and it may be possible to avoid it by using estate planning strategies such as creating a living trust or joint tenancy. Talking to an attorney about estate planning can help you determine the best way to handle your situation.

Selling A House While It Is In Probate

Selling a house during probate can be a complex process, and following the proper legal procedures is essential. If you want to sell your inherited property during the probate process, you might have to go through additional steps, including:

• Obtain probate court approval: Before selling the property, the executor or administrator must obtain written approval from the probate court, either through an “order confirming the sale” or a “license to sell.” This step may require filing a motion or petition to sell and a legal notice in the local newspaper to inform potential heirs or beneficiaries of the proposed sale.
• Determine the property’s value: Get a professional appraisal or a broker’s price opinion to determine the fair market value of the property. This information is useful for setting the asking price, and it may be required by the court to ensure that the property is being sold at a fair price to benefit the estate.
• List the property: When the court has given its blessing, list the property with a licensed real estate agent with experience in probate transactions. They can offer suggestions on how to sell the house and draw in potential purchasers.
• Review and accept offers: As the executor or administrator, you are responsible for reviewing any submissions received and negotiating the sales price in the best interest of the estate. Once you have an acceptable offer, you may need to submit a notice of proposed action to the court and any interested parties detailing the terms of the sale.
• Conduct a probate court hearing: In some jurisdictions, a confirmation hearing may be necessary for the probate court to approve the sale. During the hearing, the court may open the floor for any higher bids, and interested buyers can submit their proposals. The highest and best offer is usually accepted by the court.
• Complete the transaction: Upon court approval of the sale, the buyer deposits the funds, and the executor or administrator transfers the title to the buyer at the closing. Once the sale is complete, the proceeds are distributed to the estate to pay off debts, taxes, and expenses before any remaining funds are distributed to heirs or beneficiaries according to the decedent’s will or intestate succession laws.

You should note that this is only an example of what might occur, and your mileage may vary depending on your state and jurisdiction.

Does An Inherited Property Subject You To Capital Gains Tax?

When you inherit a property, you typically receive a stepped-up basis, which means that the basis of the property is now its fair market value as of the date of the decedent’s death (or an alternative valuation date, if the estate so chooses). Capital gains tax comes into play when you sell the inherited property. If you sell the property for more than your stepped-up basis, you generally will owe capital gains tax on the profit. For example, suppose you inherit a property with a fair market value of $300,000 at the time of the decedent’s death. This value becomes your stepped-up basis. Later on, you sell the property for $350,000. In this case, you would generally owe capital gains tax on the $50,000 profit ($350,000 sale price minus $300,000 stepped-up basis). 

However, if you decide to live in the property and use it as your primary residence for at least two years before selling, you may be able to exclude up to $250,000 of capital gains if you’re a single taxpayer or up to $500,000 if married and filing jointly, as per the Section 121 exclusion. Note that you would only be eligible for this exclusion if you meet specific IRS requirements. Generally speaking, inheriting a property doesn’t directly subject you to capital gains tax. 

However, you may owe capital gains tax when you sell an inherited property, depending on the selling price, your stepped-up basis, and any applicable exclusions. To put it another way, assuming everything else is equal, any taxes owed on a sale will result from any increase in the property’s value once you have received it. 

How Do You Figure Out Capital Gains Tax On Inherited Properties?

The difference between the property’s sale price and your stepped-up basis determines capital gains taxes on inherited property. If you are unsure, you can take the following steps to get an idea of what you might have to pay:

1. Determine the stepped-up basis: When you inherit a property, your basis is generally the property’s fair market value as of the date of the decedent’s death (or an alternate valuation date, if chosen by the estate). This is called the “stepped-up basis.”
2. Calculate the net selling price: When you sell the inherited property, determine the net selling price by deducting any selling expenses, such as real estate agent commissions, advertising costs, and legal fees, from the gross selling price.
3. Determine the capital gain (or loss): Subtract the stepped-up basis from the net selling price to calculate your capital gain (or loss). If the net selling price is higher than the stepped-up basis, you have a capital gain. If the net selling price is lower than the stepped-up basis, you have a capital loss.
4. Calculate the taxable capital gain: If you have a capital gain after applying any applicable exclusions, this is the amount subject to capital gains tax. Report this taxable capital gain on your income tax return and pay the appropriate tax based on your income tax bracket and holding period.

Tax Reporting When Selling Inherited Property

Once you are pretty sure about the amount of tax (if any) you will pay, you will still have to report the sale on your tax return. You’ll need to report the sale of the inherited property on your income tax return, usually by completing the following:

• Form 8949 (Sales and Other Dispositions of Capital Assets): On this form, detail the sale of the inherited property, providing the date acquired, date sold, cost basis, and amount of gain or loss.
• Schedule D (Capital Gains and Losses): Transfer the information from Form 8949 to Schedule D. This form is used to calculate your total taxable gains or deductible losses for the tax year.
• Additional Forms as Needed: Depending on your situation and the type of property you’re selling, other forms might also be required, such as Schedule E for a rental property or Form 4797 for business property.

Tips For Minimizing Tax Liability When Selling An Inherited Property

There are some strategies to reduce the amount of tax relief you may be entitled to if you are concerned about paying too much. While you can never truly escape the long arm of the IRS, you can use the following options to try to reduce the burden as much as possible:

• Use the stepped-up basis: As explained earlier, when you inherit property, your tax basis is generally the fair market value on the date of the decedent’s death or an alternate valuation date if elected by the estate. Using the stepped-up basis instead of the original purchase price can significantly reduce your taxable gain upon selling.
• Hold for long-term capital gains: Unlike short-term capital gains, long-term gains from property held for more than a year are often taxed at a lower rate. Consider keeping the property for more than a year before selling in order to take advantage of the lower tax rates, if at all possible.
• Offset gains with losses: If you have capital losses from the sale of other assets, you can offset the profits from selling the inherited property. The loss from one asset can help reduce or eliminate the taxable gain from the sale of the inherited property.
• Convert the property to your primary residence: If you decide to live in the inherited property as your primary residence for at least two years out of the last five years before selling, you might qualify for the home sale exclusion. 
• Sell the property as part of a 1031 exchange: If you’re planning to invest in another property, you could consider a Section 1031 exchange (also known as a like-kind or Starker exchange). However, strict rules govern 1031 exchanges, so consult with a tax professional before proceeding.
• Donate the property to charity: If you value philanthropy, consider donating the inherited property to a qualified charity. You might be eligible for an income tax deduction based on the property’s fair market value and avoid paying capital gains tax altogether.

Although receiving a new property as part of an inheritance is a rare occurrence, when it does, your net worth can rise dramatically overnight. However, unless you understand the tax rules, you may be in for a nasty surprise if you decide to sell it. By taking the time to know your options, you will be in a far better position to reduce your burden and gain from your loss.