How to Avoid Paying Capital Gains Tax on Inherited Property

Inheriting property can be burdening, and one such potential burden is capital gains tax, a levy on the profit earned from selling an asset that has increased in value. But you are in luck because navigating capital gains tax on an inherited property doesn’t have to be a nightmare.

Here are some strategies to consider when aiming to sidestep capital gains tax on your inherited real estate.

What Capital Gains Tax Means

Capital gains tax might seem complex, but it’s simply a tax levied on your profit when you sell an asset that has increased in value. This applies to various things, from an inherited house to stocks and cars.

The key factor deciding the amount you pay is how long you owned the asset:

  • Short-term (1 year or less): The tax you will pay depends on your profit. And you’ll pay this tax at your regular income tax rate, just like your salary. 
  • Long-term (over 1 year): The longer you own a property, you get to enjoy the bonus lower tax rates! Depending on your income and filing status, you’ll pay either 0%, 15%, or 20% on your profit. And usually, the higher your income, the higher the long-term capital gains tax rate you’ll pay.

Keep in mind that some states in the US have additional capital gains tax, ranging from 2.90% to 13.30%.

But worry not, nine states (Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming) forego this extra bit of tax.

5 Ways to Avoid Capital Gains Tax on Your Inherited Property 

If you are looking to avoid capital gains tax on your inherited property, here are 5 ways to go about it:

1. Selling Your Inherited Property Quickly

If you’re not emotionally attached to your property and the market is favorable, consider selling it immediately

As long as the sale price doesn’t exceed the fair market value at the time of inheritance, you won’t incur any capital gains.

When you inherit property, a unique thing happens called the “step-up basis.” This means the IRS ignores the original purchase price and uses the property’s value at the date of inheritance as its new baseline for calculating capital gains tax.

But here’s the catch. This benefit only applies to the value of the property as of the death of its previous owner, not any future appreciation.

So, selling quickly locks in that lower starting point for your capital gains calculation. Every day the property sits unsold, its potential value (and your potential tax bill) keeps climbing.

Time is money when it comes to inherited property and capital gains tax. Selling quickly lets you leverage the step-up basis to your advantage and potentially keep more of your money.

2. Disclaimer Power

You can say, “no thanks” to the property and its potential tax burden. This legal maneuver lets you skip inheriting the asset completely, along with any capital gains tax that might come up when you sell it. 

Disclaiming can also simplify things if managing the property seems overwhelming or if family dynamics around the inheritance are messy. By saying no, you avoid potential conflicts and legal complexities.

Once you disclaim, it’s final. The property goes to the next in line, and you can’t change your mind later. Make sure you’re 100% comfortable giving up the asset before taking this step.

Disclaiming an inheritance is a powerful tool to avoid capital gains tax, but it’s not a one-size-fits-all solution. Weigh the pros and cons carefully, and get professional advice to ensure you’re making the right move for your circumstances.

3. Make It Your Home

Setting up your home in your inherited property could unlock the safety of the personal residence exclusion. This tax rule lets you skip paying capital gains tax on up to $250,000 for individuals and $500,000 for married couples when you sell the property.

But there is a condition you must meet. You can enjoy this exclusion as long as you live there for at least two out of the five years before selling.

But there are things to consider. Two years is a significant chunk of time, so ensure you’re comfortable living in the inherited property before making a decision.

Also, plan your sale strategically to maximize the two years within the five-year window. Consult a tax professional to ensure you meet all the qualifications and optimize your tax benefits. 

4. Turn Your Inherited Property into a Rental

You can transform your capital gains tax burden into rental income and tax-free gains by simply turning your property into a cash flow source.

Unlike selling, renting lets you hold onto the property for as long as you want, enjoying rental income and potential future appreciation. No need to rush into a taxable sale to avoid capital gains.

If you eventually decide to sell, a 1031 tax-deferred exchange can be your savior. Sell the inherited property and reinvest the proceeds in another rental property within specific timeframes.

This magical maneuver defers your capital gains until you sell the new property, giving you more time and flexibility. Rental income itself can be a profitable tax benefit.

Depreciation deductions allow you to offset rental income with a portion of the property’s value, potentially lowering your taxable income.

However, being a landlord comes with responsibilities like:

  • finding tenants
  • handling repairs
  • managing paperwork

Consider these commitments before you rent out your property.

5. Get a Break on Capital Gains with Special Circumstances

If you need to sell the inherited property due to a significant life change, you might be eligible for a partial capital gains exclusion. Think of it as a safety net that catches some of that tax bite.

Certain unforeseen events qualify you for partial exclusion. They are:

  • job relocation
  • serious illness
  • sudden disaster

So this has to be a circumstance beyond your control compelling you to sell.

Depending on the situation and how you inherited the property, you might be able to exclude a portion of the capital gain from taxation. That means less money going to the government and more staying in your pocket.

Not all life changes make the cut. Consult a tax professional to see if your situation fits the exclusion criteria.

How you inherited the property and how long you lived in it can affect the exclusion amount. Be prepared to back up your claim with solid proof of the life change that forced the sale. 

Sell Your House the Grandview Homes Way

Want to avoid the hassle of paying capital gains tax? Look no further than Grandview Homes, your stress-free solution for a fast and as-is sale of your property.

Whether you’re downsizing for retirement or inherited a property, we offer a refreshingly simple way to sell in less than 10 days.

At Grandview, we handle everything – from initial contact to closing – with transparency and care. You don’t even need to lift a finger on repairs or cleaning, we take care of it all.

Contact us immediately to embark on a smooth sales journey.

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