Heirs who inherit property or expect to inherit property will generally have a number of tax questions. Are taxes due now or only when I sell? Are taxes owed in the future? How much in taxes will I have to pay?
The good news is that there isn’t a federal inheritance tax. An inheritance tax is applied when the inherited property is received. But we are talking about selling land that has already been inherited. There isn’t a simple answer to this question, as it will depend on several variables. Let’s take a look at what those variables are.
A basis is the cost average of a property. This is not to be confused with the purchase price, which is a component of the basis. The basis is the purchase price + improvements - depreciation.
Using the above explanation, the basis can be less than the original purchase price. However, if the property has appreciated, it will likely be more than the purchase price.
The basis is the value used when calculating the profit on a sale. For example, if the basis of a property is $300,000 and it is sold for $400,000, the gross profit is $100,000. Selling costs and other fees must be subtracted to get the taxable profit.
The basis of an inherited asset is the market value. This includes land, a home, and stocks. If the property is sold right after being inherited, it will be sold at the market value (its basis), resulting in no taxes due on the sale. This is called a step-up in basis since the basis steps up from the original basis to the current market value.
It works in the other direction as well. If inherited land is sold for less than the market value when it was inherited, a loss can be declared.
Some states have an inheritance tax. This tax is paid at the time of inheritance, regardless if the property is sold. These states include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.
There are also states with excise/transfer tax, which you can see here.
If property is transferred from the parents to children while the parents are living, the children will not get a step up in basis. Their basis will be the parent’s original basis. If the children try to sell the property and it has appreciated since the parents purchased it, a large capital gains tax bill will likely be due. It’s also possible the children will owe the 3.8% net investment income tax (NIIT).
Most land is purchased without a mortgage since few mortgages qualify for a land purchase. However, heirs will take over the payments if the land is inherited with a mortgage. This isn’t any different than if a home with a mortgage was inherited.
Because inheritances can be a complex topic and taxation varies across states, it’s best to work with a tax specialist before inheriting any property.