Inheriting a home from a loved one can be blessing – particularly if you can make it your family home. It’s even better if the mortgage is paid off so that you can own it “free and clear.” Even if you have no interest in living in it or using it as a rental or vacation property, it can be worth a large amount of money if you sell it. That’s especially true if you don’t have to put a lot of money into upgrading and remodeling it.
Yet, whether someone is offered a home by a loved one who’s doing their estate planning or they learn after the loved one is deceased that they left them their home, they often have concerns about whether they’ll have to pay capital gains tax on it. If someone inherits a home that a parent purchased many decades ago, they may fear that could have to pay this tax on hundreds of thousands of dollars in appreciated value.
Understanding the “stepped-up basis” rule
If you have inherited a house, know that capital gains tax won’t come into play unless and until you sell the property. Just inheriting an asset that’s worth a lot more than when it was first acquired doesn’t make you responsible for any capital gains tax. Second, under the IRS’s “stepped-up basis” rule, you’ll only have to pay capital gains tax on the amount that has increased in value since you took ownership of it.
Say you’ve inherited a home that your parents paid $30,000 for in the 1970s. The architect later became famous and the neighborhood is thriving, so it’s worth $300,000 now. You keep the home for a few years and then sell it for $400,000. You’d only be responsible for the stepped-up capital gain of $100,000 – the difference between the value when you inherited it and when you sold it. If you make the home your primary residence, that amount can be excluded on your income taxes under tax law.
Of course, if you’ve inherited any asset worth a considerable amount and you’re considering whether to accept the asset or decline (“disclaim”) it, it’s wise to consult with a financial and/or tax professional to weigh the pros and cons – and so that you don’t make decisions based on false assumptions. It’s also wise to have legal guidance as well – particularly if you’re considering disclaiming an inheritance — so that you comply with the law as you move forward.