Understanding capital gains tax on an inherited home

While there’s no state inheritance tax in California, that doesn’t mean you’re completely in the clear from taxes after a loved one dies. For example, you may have to pay capital gains tax if you inherit property and then sell it.

However, fortunately, it’s not as bad as it could be. That’s because of the “step up in basis” rule. That limits the amount of capital gains tax that beneficiaries pay if a property has increased in value significantly over time.

How the “step up in basis” rule works

Real estate is where this rule most often comes into play. Say you inherited your mother’s home, which was purchased decades ago for $50,000. Her neighborhood is now in one of the most popular areas in the city. At the time of her death, it’s valued at $400,000.

Say you keep it for six months or so while you’re cleaning it out and doing some repairs. By the time you sell it, the market’s gotten even hotter, and you get $475,000. Instead of having to pay taxes on $425,000 in capital gain ($475,000 – $50,000), you only owe them on the “stepped-up” value, which is the difference between the value at her death and the price you get for it — $75,000. If you had turned around and sold it right away for $400,000, you’d likely have no capital gains.

The amount of capital gains tax you pay, even on inherited property, depends in part on your own income tax bracket. That’s something to consider.

If a loved one recently bought their home and it decreased in value, you’d be able to claim a capital loss. Again, however, that would be based on the difference between the value at their death and the sale price of the home.

Inheriting a home comes with some burdens

There’s a lot to think about if you inherit a home – particularly one you don’t want to live in. That’s why some people ask their loved ones not to leave them their home in their estate plan. If you inherit a home, you’re responsible for paying the mortgage if there is one, and for paying property taxes and insurance until you sell it.

It’s wise to seek legal, tax and real estate guidance if you’re dealing with a high-value piece of property. This can help you make the best decision for you and your finances.