Taxes on inherited property are something that heirs will have to deal with rather than the owner of the estate. However, there are variations across states. Texas is one of those states that falls into a special category when it comes to capital gains on inherited properties.
Note that an estate tax is a tax on the estate. An inheritance tax is a tax that heirs pay on inherited property. There is currently no federal inheritance tax.
However, there is a federal estate tax. This tax only applies at the estate level and isn’t applicable to heirs. No matter which state the estate is in, federal estate taxes must be paid. They can range from 18% to 40%. However, this tax is also dependent on the value of the estate. In 2023, estates with a value less than or equal to $12.92 million do not have to pay an estate tax.
Most people's estates won’t have to pay a federal estate tax, given how high the exemption threshold is.
For those who do have to pay a federal estate tax (i.e., the value is over the threshold), the tax is levied on the fair market value of the estate.
In 2023, six states imposed an inheritance tax. These include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. As you can see, Texas is not one of these states. Therefore, those inheriting property in Texas do not have to pay an inheritance tax at the state level.
Many states do have estate taxes. Some states have flat estate taxes, and some have a progressive estate tax. In a progressive estate tax, taxes increase with the value of the inheritance. Then, there are states with no estate tax. Texas falls into this latter category.
However, Texas heirs may still be affected by the federal estate tax based on the estate's value (see above section for thresholds). If the estate is accessed a federal estate tax, the estate's value will be decreased by the amount of taxes and liabilities. What's left over is the amount inherited by heirs.
In Texas, those living in the inherited property as their primary residence can qualify for the homestead exemption as an “heir property owner.” This exemption will reduce property taxes on the inherited property.
While Texas doesn’t have an income or inheritance tax, it does have high property taxes. However, property taxes are not collected by the state. Instead, they are collected by the counties.
Property taxes are due every year. In some cases, a property may have back taxes, which can add to the financial burden of heirs.
When property is inherited, heirs receive it at a step-up in basis. The cost basis for heirs is the market value. So, there are no federal capital gains owed. If the property appreciates, heirs still do not owe capital gains. It isn’t until the appreciated property is sold that capital gains are owed.
If the property is immediately sold, it probably didn’t have time to appreciate. If there was no appreciation or the property decreased in value, capital gains taxes would not be owed.
While Texas doesn’t have an inheritance tax, federal capital gains taxes will apply for properties that have appreciated and are sold since being inherited.
The various taxes that may be involved in inherited property can get complex. It's best to work with a tax professional to determine any taxes that you might owe on inherited property.