Will I Have to Pay Income Tax on an Inherited House?

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Welcome to the “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.

Today’s question is about paying income taxes when you sell an inherited asset; in this case, a house.

Watch the following video, and you’ll pick up some valuable info. Or, if you prefer, scroll down to read the full transcript and find out what I said.

You also can learn how to send in a question of your own below.

For more information, check out “8 Documents That Are Essential to Planning Your Estate” and “Do I Really Need a Will?” You can also go to the search at the top of this page, put in the words “taxes” or “estate planning” and find plenty of information on just about everything relating to this topic.

And if you need anything from tips on finding a better savings account to finding the best financial advice, be sure and visit our Solutions Center.

Got a question of your own to ask? Scroll down past the transcript.

Don’t want to watch? Here’s what I said in the video

Hello, and welcome to your “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this answer is brought to you by Money Talks News, serving up the best in personal finance news and advice since 1991.

Today’s question comes from Ann:

“I’m selling a house inherited from my mother. What kind of tax implications am I facing? I live in Texas where there is no state income tax.”

OK, Ann, let’s discuss.

As we begin this discussion, keep in mind that we’re talking about income taxes, not estate taxes.

The beauty of an inheritance

When you inherit something, you don’t owe income tax. Gifts and inheritances aren’t considered taxable income.

But if you sell something you inherited, you could owe tax on the gain.

When you inherit things like real estate, odds are good it will be worth more than it was when the original owner bought it. In this case, for example, Ann inherited a house from her mother. Ann is concerned that when she sells her inherited house, she’ll have a big gain and a big income tax bill to go with it.

Thankfully, however, that’s not the case.

When you inherit real estate, its original purchase price, known as its “basis” for tax purposes, is increased to the value as of the date of death. This is known as a “stepped up” basis.

Example: Ann’s mom buys a house in 1970 for $100,000. When Ann’s mom passes away, the house is worth $500,000. For tax purposes, the cost, or basis, of the house is now “stepped up” to $500,000. If Ann sells it at that price, she has no taxable gain to report. If she sells it for less than that price, she may even have a taxable loss to report.

This rule is also true when you inherit things like stocks (except if they are in vehicles such as a 401(k) or IRA) or other things that have a cost basis. Stepped up basis is why it’s typically better to inherit something than to get it as a gift.

Receiving a gift

When you’re gifted an asset, the good news is that, as when you inherit, there’s no income tax due. The bad news, however, is that you don’t get to step up the basis as you do with inheritances.

When someone gives you something, your tax basis is the same as theirs. So if Ann’s mom had gifted her the house rather than leaving it to her, Ann’s tax basis would have been $100,000, the same as her mom’s. If she immediately sells the house for $500,000, her $400,000 profit would be taxed like all Ann’s other income. That means she could pay up to 37% of her gain in taxes. On a $400,000 gain, that’s $148,000.

What could Ann do in this case? Well, if she keeps her gift house for more than a year, she’d qualify for long-term capital gains treatment, meaning the profit would be taxed at a lower rate. If she kept the house for more than a year, the most she’d pay is 20%, or $80,000. So, keeping the house for a year would save her $68,000.

There is one last thing Ann could do to lower her taxes, and you might be able to do it as well when you sell your house. It’s called the home sale exclusion.

Here’s how it works: If you live in your home for at least two of the last five years, you don’t have to pay taxes on the first $250,000 of the gain if you’re single — or $500,000 if you’re married filing a joint return — providing you haven’t already claimed the exclusion during the past two years.

So think about this: Ann gets a house as a gift and decides to sell it. She could owe nearly $150,000 if she sells it right away, $68,000 if she waits a year, and potentially nothing at all if she moves in and waits two years.

And this, my friends, is why we always talk to a tax expert before we make major money moves!

Hope that answers your question, Ann. Now, what about you? Got a question of your own to ask? Then do what Ann did: Simply hit “reply” to any Money Talks email newsletter and fire away. I can’t answer every question, but I do my best.

And if you’re not getting our newsletter? Fix that right now by going to Money Talks News and subscribing. It’s free, takes five seconds and will absolutely, positively make you richer.

I’m Stacy Johnson. See you here next time!

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The questions I’m likeliest to answer are those that come from our members. You can learn how to become one here. Also, questions should be of interest to other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.

About me

I founded Money Talks News in 1991. I’m a CPA, and I’ve also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.

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