What you should know about selling an inherited home

Selling an inherited home

According to recent studies, younger generations worldwide stand to inherit as much as $30 trillion in assets over the next 30 to 40 years.  A good part of that will be in the form of inheriting a home, often the most valuable asset in an estate.  But if you’re not well armed with the information you need, what you do with that inherited home can end up unnecessarily costing you thousands of dollars.

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How do you determine fair market value of an inherited home?

Estate taxes are due on the value of an estate when a person dies.  Under the Tax Cuts and Jobs Act passed in 2017, the federal government increased the basic exclusion amount for estate taxes to $10 million.  Adjusted for inflation, that amount grew to $11,180,000 in 2018.

Taxes on estates worth that much – including real estate, stocks and bank accounts – will be paid by the estate, rather than the heirs, so determining the value of inherited real estate is an important task. 

From the point of view of the IRS, the most acceptable indicator the fair market value of an inherited home is the actual sale price, as long as it’s sold within a year of the relative’s death, unless it is sold at a deep discount to a family member or a friendly party. 

The other acceptable way to determine fair market value is to hire a certified appraiser who will inspect the property and review comparable sale prices as part delivering an accurate estimate to you.

Considerations before selling

Determining fair market value is just one of the things you should consider before selling an inherited property.

Aside from any disagreements that may arise between beneficiaries about what to do with a property, there are several financial issues to consider as well.

Some states impose an inheritance tax, but the good news is that Missouri is not one of them. Six states impose an inheritance tax – Kentucky, Iowa, Nebraska, New Jersey, Maryland and Pennsylvania.

These states impose inheritance taxes anywhere between 1 percent and 20 percent of the value of the house and other assets you’ve inherited. There are exemptions, and you typically only pay inheritance tax for inheritances larger than the exempted value, but you need to be aware of this if you inherit a property in one of those states.

As mentioned above, you will also need to consider how estate taxes will impact what happens to a property as well.

Make sure the sale itself will not be taxable. That would depend on the heirs’ basis, which in the case of inherited property is the home’s value, including improvements, on the decedent’s death date. Most sales won’t net enough to be concerned about the sellers’ IRS maximum profit exclusion amount of $250,000 for a single person or $500,000 if married and filing jointly.

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What about property taxes on an inherited home?

If you inherit a home, you may have to pay property taxes as soon as you inherit the property.  At the very least, you will need to continue to pay property taxes for as long as the home is owned by you or a trust.

Many states cap how much the assessed property value can rise from year to year, but when someone buys or inherits real estate, it is often reassessed at current market value. Even if subsequent assessments are capped, the initial reassessment can result in heirs paying thousands of dollars more in taxes than the previous owner.

Some states, such as California, offer an exemption.  If the heir is the spouse or child of the owner, there is no reassessment.

Reporting the sale of an inherited home on your tax return

The tax law provides homeowners with a very generous tax exclusion when they sell their property. Up to $250,000 of any gain from such a sale received by a single homeowner is tax free. For married homeowners filing jointly, up to $500,000 of gain is excluded from income. To qualify for the exclusion, the home must have been used as a main home for two years out of the prior five years before the sale.

At the time you inherit a home, you won’t qualify for this exclusion. You’d have to move into the home and live there for at least two years to qualify.

However, when you inherit property after the owner dies you automatically receive a “stepped-up basis.” This means that the home’s cost for tax purposes is not what the now-deceased prior owner paid for it. Instead, its basis is its fair market value at the date of the prior owner’s death.

The bottom line is that if you inherit property and later sell it, you pay capital gains tax based only on the value of the property as of the date of death.  So, if a home was appraised at $375,000 at the time of the decedent’s death, but you held on to the home and later sold it for $400,000, you only need to pay taxable gains on $25,000 worth of increased value.

Can you sell an inherited property before probate?

In the vast majority of cases, the answer is no. 

Most title companies will not be willing to agree to a sale until a probate case is filed.  When that happens, a title company has the legal proof they need stating that an executor is entitled to sell a decedent’s property.  If a title company allows the sale of a home that didn’t go through proper channels, then the buyers can sue the title company and the person who tried to sell the home.

As such, an executor can only sell a home during probate or after probate has been finalized.

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Selling an inherited home owned in a trust

Selling a home that is part of a trust is not that much different from selling a home that you own.

A trustee will conduct the sale of the home and transfer assets into the trust or the trustee will transfer the title of the property into your name if you are the designated beneficiary so that you can sell the home. 

For your own protection, it is probably best to consult your CPA, attorney or financial planner to makes sure that all state laws and regulations are followed regarding the transfer of the proceeds or the property. 

Is it possible to avoid capital gains tax?

You might avoid capital gains tax entirely if you hold on to the house for five years before selling, and if you live in it and make it your primary residence for two of those years.

This qualifies you for a $250,000 federal capital gains exemption if you’re single, or a $500,000 exemption if you’re married and file a joint return.

Definitions you should know

What is Cost basis?

When property or other assets are inherited, the cost basis is usually equal to the fair market value of the property at the time of the decedent’s death or time of actual transfer.

Gifts and inheritances – These are treated differently by the IRS for tax purposes.  Gifts can be given tax free up to the annual exclusion amount.  Inherited property will be treated much differently for tax purposes.

What is Fair market value?

Fair market value (FMV) is the price that property would sell for on the open market.

Capital gains tax

Capital gains are profits from the sale of specific types of assets, including real estate. This tax is calculated on the profit – or positive difference – between the sale price and the original purchase price of the asset.

Step-up basis

A step-up in basis is the readjustment of the value of an appreciated asset, such as a home for tax purposes upon inheritance.  It is determined to be the higher market value of the asset at the time of inheritance.

Holding period

A holding period is the amount of time an asset is held or the period between the acquisition and sale of a security. The holding period is used to determine the taxing of capital gains or losses.  No matter how long property or assets are actually held, either by the decedent or the inheriting party, inherited property is considered to have a holding period greater than one year. Thus, capital gains or losses are designated as long-term capital gains or losses. Under current tax law, long-term capital gains are taxed at a more favorable, lower rate than the normal income tax rate.

Related Articles

  1. How to Sell Your House Fast
  2. Guide to Home Staging
  3. Choosing a Real Estate Agent
  4. Understanding the ins and outs of home inspections
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