Although most taxpayers are familiar with the basics of income taxes – you pay taxes on all income you receive – estate taxes operate in a much different fashion. Instead of taxing the heirs who receive portions of an estate, the Internal Revenue Service assesses estate taxes against the value of the estate before executors divide it among heirs. Because of this, if you inherited a house, all estate taxes associated with it, if any, were paid before you received it, and you aren’t taxed simply for receiving the home. When you sell it, however, you’ll be liable for any capital gains on the home, with special rules about calculating the tax basis of inherited property.
1. Determine the home’s value on the date that its previous owner died, not the date on which it passed into your possession. A professional, preferably licensed, assessor can make a backdated assessment of a property you’ve held for years if it wasn’t assessed when you received it. The home’s value on the prior owner’s date of death serves in the same way as its purchase cost would have if you bought it, establishing the tax basis for the home.
2. Calculate the adjusted basis on the home. Any improvements you made to the home while you had it increase its value – you’ll need an assessor to determine by how much – and any costs associated with the sale of the home, such as advertising, realtor fees and title transfer fees you pay for may also be included in the home’s adjusted basis.
3. Determine your gain or loss after you sell the home by subtracting the basis from the sale price. Use Schedule D to report this sale. Inherited property always qualifies for long-term gains rates, regardless of how long you held it before selling it, so list the property sale in Part II of the schedule. If you sold the home for less than its appraised value, you can’t claim a loss, as you didn’t have any income directly invested in the property.
4. Complete Schedule D, listing any other relevant short- and long-term investment gains and using the calculations provided by the IRS to compute your capital gains liability. If the only capital asset you sold in the year was the inherited house and you earned less than $34,500, or less than $69,000 as a married couple, you won’t pay gains capital gains taxes. Otherwise, you’ll pay 15 percent on the realized gains, or profits.
5. Transfer the realized gains and offset losses you determined on Schedule D to Line 13 of your Form 1040, in the “Income” section. Submit Schedule D with other tax paperwork when you file your return.
- If you owned and lived in the inherited home for at least two years before you sold it, you may claim a homeowner exclusion on capital gains taxes. This exclusion exempts the first $250,000 in gains on your primary residence.
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