Saving Taxes on Inherited Property

When a loved one passes away and leaves behind real property—whether it's a family home or investment property—the last thing most people consider immediately is taxes. However, the way inherited property is treated tax-wise can have significant implications on your finances. One of the most beneficial tax concepts for heirs and beneficiaries is the "stepped-up basis."

What Is the Stepped-Up Basis?

In simple terms, basis is the amount of your capital investment in property—i.e., how much it cost. A “stepped-up” basis means the cost basis of inherited property is adjusted to the property's market value at the time of the owner's death. This adjustment can significantly reduce the taxes you might otherwise owe when you sell the inherited property.

Consider this common scenario:

• Your parents purchased a home 30 years ago for $50,000.

• Over time, the home's value has increased significantly, and it is now worth $300,000.

If you inherited the home and later decided to sell it without stepped-up basis rules, you'd owe taxes on the $250,000 gain ($300,000 selling price minus the original $50,000 purchase price). However, thanks to the stepped-up basis, your new basis in the home is the market value at the time of your parents' passing—$300,000. If you sell the home for this amount shortly after inheriting it, you would owe no capital gains tax.

How Does This Benefit You?

The stepped-up basis is a powerful tax-saving tool because it can significantly reduce the amount you owe in capital gains taxes. Without this rule, beneficiaries could face substantial taxes, especially on assets like stocks and real estate that typically appreciate greatly over time.

When the Stepped-Up Basis Doesn't Apply

It's important to note when the stepped-up basis won't apply. If property is gifted while the original owner is alive, the recipient typically inherits the original owner's basis. This can become problematic, especially with large lifetime gifts, because the recipient may later face a significant capital gains tax bill.

For example, if a parent gifts a home that has appreciated significantly over many years, the child receiving the gift would inherit the parent's original low basis. When the child sells the property, they must pay taxes on the entire gain from the original purchase price, potentially leading to substantial tax obligations.

Final Thought

When you inherit property, particularly property which you intend to sell, documenting the property's market value at the time of inheritance is crucial. A professional appraisal provides credible evidence to support your stepped-up basis. Retain any appraisal reports and related documents. Accurate records make it easier when it's time to sell.

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