If someone passed on and left you an inheritance property you might be wondering if you owe taxes on it.
Many people don’t know what to do with their sudden inheritance. If you don’t need or want the home you can sell it, but do you have to pay taxes on inheritance properties?
That depends on many factors including how long before you sell the home and whether you decide to use it as a main residence.
If you do owe taxes, understanding tax laws on inheritance homes can be confusing. After all, not all states have the same tax laws. There are also taxes on a federal level to consider.
Learn all about taxes on inherited properties and discover how to sell your home in this guide.
Types of Taxes on Inherited Properties
When you sell your inheritance property, any profits are subject to tax. There are several different taxes that you might owe if you received an inheritance home. These include a capital gains tax, an inheritance tax, and an estate tax.
Federal Taxes
According to the IRS, you must determine your basis in the property to figure out how much you will owe on the sale of your inheritance. Your tax basis is the fair market value (FMV) of the home on the day of the decedent’s death.
You may choose to sell your inheritance home immediately or to hold onto it. There are many reasons people wait to sell, such as waiting until market conditions improve. But remember, inheritances and properties increase in value over time and you will owe the IRS on your capital gains tax.
States with Inheritance Taxes
When it comes to inheritance, only a handful of states collect an inheritance tax. As of 2018, the six states that have an inheritance tax are Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
Of these six, the inheritance tax rates vary from state to state. Larger inheritances mean higher tax brackets as well.
Estate Taxes
As of 2019, the federal tax exemption on estate taxes is $11.4 million. That’s an increase from last year. This means that if your inheritance property is worth less than that you won’t owe estate taxes on the federal level.
Twelve states, as well as the District of Columbia, collect estate taxes. These states include Connecticut, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, and Washington.
The exemption in each of these states varies but the amount is far less than the federal exemption.
The Capital Gains Tax
If you make more on the sale of your inheritance, you owe a capital gains tax. To figure out the taxable amount, determine the difference between the worth of the asset and the amount you receive from the sale. The capital gain you make on the sale of your home is taxable.
For instance, if the FMV of your inherited property is $200,000 and you sell it for $225,000, you owe a capital gains tax on that $25,000.
When an inheritance home passes to a beneficiary, it receives a step-up basis or a value readjustment. A stepped up basis means your capital gains tax will be lower.
If you hold onto an inheritance property and it increases in value, you’ll owe on that capital gain. But is there a reason to keep an inheritance property for a few years before selling it?
Federal Tax Breaks
It’s tax time again and you’ve been sitting on an inheritance home. You might be hoping that you qualify for some tax breaks. There is an exclusion on the sale of inherited homes, but do you qualify?
The IRS states that you could qualify to exclude $250,000 on the capital gain of your home from your income. And if you file jointly with a spouse, you could exclude up to $500,000.
Qualifying individuals must meet two conditions: the ownership test and the use test. Individuals must have owned and used the property as their main home for two out of five years before the sale.
You need to live in the home and label it as your main residence for at least two years. This means you won’t qualify for this tax break immediately upon inheriting your property.
See Publication 523 to figure out if you’re eligible for this tax break and complete the requirements.
Disclaiming an Inheritance
If you want to avoid taxes altogether, you can disclaim your inheritance. You will need to provide a written statement to an estate executor claiming you don’t want the property.
You have nine months to disclaim an inheritance property. At this point, it goes to the next heir. By disclaiming an inheritance home, you won’t receive any gains or benefits.
Do You Have to Pay Taxes on Inheritance Homes If You Make Home Improvements?
Many inherited homes are older buildings that need updating. Often people choose to remodel or renovate their home before selling it. By doing so, you receive a higher return on investment.
The value of the home will likely increase, meaning you’ll owe capital gains taxes. But if you keep track of your receipts you can still lower your tax bill. Simply subtract the amount you spent on upgrades from the sale price of your home.
There’s no doubt that making home improvements takes a lot of time and effort. Not everyone has the skills or budget to devote to home renovations, either.
If you don’t have the time or the money to put toward improvements, sell your home as-is instead.
What to Do Before Selling Your Inheritance Home
The different taxes and tax laws can be confusing when it comes to inheritance properties. When it comes down to it, do you have to pay taxes on inheritance homes?
Generally, the answer is yes. But if you’re uncertain how much you’ll owe or if you qualify for any tax breaks, consider talking to a tax accountant. It’s best to do this before you sell your property and well before tax time.
If you need to sell your property in Colorado Springs, we can help you sell your inheritance home fast. If you plan on selling your home with us, take these few steps first to make the process easier.
