Taxes When Inheriting Property
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When you inherit a property, there are several taxes you should be aware of including property taxes, income taxes, estate taxes, inheritance taxes, and capital gains taxes.
Property Taxes
Property taxes are usually the responsibility of the current property owner. Unlike other debts, property taxes don’t get wiped out when someone dies.
Before an estate is settled, the executor is usually responsible for paying any property taxes owed from the estate assets. Once you formally inherit the property, you’ll be responsible for the property taxes.
Whether you’re the executor or are inheriting the property, you should immediately check for any past-due property taxes and whether property taxes have been paid for the current year. Especially if a family member was in poor health, it’s not uncommon for there to be unpaid property taxes on an inherited property.
If you’re from another state or even a different part of the same state, be aware that property tax billing timelines and payment deadlines vary by location.
Like other taxes, the longer you wait to pay property taxes, the worse it gets. This can include additional interest and penalties, a tax lien, or even losing the property in a foreclosure.
Depending on your state, the clock may not stop on tax liens and foreclosures while you’re settling the estate.
If there are a lot of unpaid property taxes, it may seem like a good idea to let the property go into foreclosure to pay off the taxes. This is usually not a good idea.
Foreclosure sales usually go for far less than open market listings. You can typically list the house and pay off the taxes at closing as long as you close before any potential foreclosure.
Income Taxes
You generally don’t owe any income taxes if you inherit property. Some states may have an inheritance tax, which we’ll discuss below.
The estate may have to file a final income tax return for the decedent. The estate may also have to file an estate tax return if the estate receives income. If the property is a rental property, income could include rent payments.
If you do inherit an income-producing property, you’ll owe income taxes on that income once you start receiving it.
Estate Tax
An estate tax is a tax paid by the estate based on the total value of the estate. The estate can include real property, investments, cash savings, and other assets.
There is a federal estate tax, and many states have estate taxes as well. Estate tax usually only applies if the estate is worth millions of dollars.
Normally, the person inheriting property doesn’t pay the estate tax. Estate tax comes out of the estate assets before inheritances are given.
In some cases, the estate may not have enough cash to pay the estate tax. This can happen when the estate has mostly illiquid assets such as a house or small business.
When an estate doesn’t have cash, it may need to sell assets to pay any estate tax. If you want to keep the house or other asset, you can arrange to pay the taxes with your own money.
Inheritance Taxes
An inheritance tax is a tax paid by the person inheriting property. There is no federal inheritance tax. Only a small number of states have inheritance taxes.
Inheritance tax can apply based on where you live, even if you inherit property in another state. It can also apply based on where the property is located, even if you live in another state.
Inheritance taxes are usually based on your total inheritance. If you receive a house and cash, you can use the cash to pay the tax.
If you only receive a house, you’ll need to use your own money to pay the tax. If you don’t have enough savings, you can try taking out a home equity loan.
If you’re unable to pay the inheritance tax, it will often work like not paying your income taxes. However, check with your state for specific details.
Capital Gains Taxes
If you sell an inherited property, you may have to pay capital gains tax. Normally, capital gains tax is the selling price minus the purchase price.
When you inherit property, there is a special rule for determining the purchase price or basis. The basis is usually the property’s value as of the date of the decedent’s death or an alternative valuation date.
The alternative valuation date is usually the earlier of six months after the decedent’s death or when you sell or transfer the property.
In other words, if you immediately sell an inherited property, you usually won’t owe capital gains taxes. However, if you hold it for a while before selling it, you’ll owe capital gains taxes on the increase in value since you inherited it.