For someone new to property investment, the occasion of an inheritance may be the start of a significant opportunity. If you have just inherited property and want to ensure that you lay the foundation to grow your wealth from the beginning, it’s a good idea to seek out trustworthy advisors to guide you. In this situation, step one is probably to determine your tax situation.
If you directly inherit property from someone, the tax situation is reasonably straightforward. There is no income tax on inherited assets, and for most people, the inheritance tax does not apply. The Tax Cuts and Jobs Act increased the tax-exempt gifts to heirs to up to $11.18 million per person or $22.36 million for a married couple. (Note that the maximum is reduced by amounts you give while living, so if you take advantage of the annual $15,000 tax-free limit in gifts to your future heirs, that decreases the total you can bequeath at your death.) The more commonly applicable tax is capital gains, which would be assessed when the heir sells the inherited property. Keep in mind that the property's tax basis is the fair market value at the time the grantor died. Any appreciation in value accumulated by the giver is erased from a tax perspective.
For example: if you buy an investment property for $10,000 and during your lifetime it increases in value to $100,000, and in your will, you leave it to your daughter, her tax basis is $100,000. If she sells it for $100,000, she does not pay a tax on the capital gain that you earned and passed along to her. However, suppose she waits, and the property continues to appreciate before she sells it. In that case, she will owe capital gains taxes on the increase in value that occurs after she assumes ownership.
If the inheritance is in the form of a trust, the tax status is more complicated. The heirs pay taxes on the income the trust has earned if the trust you establish is revocable. While the trust grantor is living, the taxes on any earnings are that person’s responsibility, but that obligation shifts to the heirs after the grantor’s death, at which time the trust will be assigned a separate tax identification number and file an annual tax return.
If you inherit from an irrevocable trust, the grantor may have established it to provide income to you and other heirs in advance of their death and transfer the assets to the legal entity of the trust to avoid inheritance taxes. The irrevocable trust has a special legal status that allows the settlor to relinquish control of and benefit from the assets placed in the trust.
Whatever the origin of your inheritance, once you can manage your asset, you can use the tools available to you to seek to minimize the recognition of taxable gains. Delaying or avoiding capital gains taxes through the use of strategies like 1031 exchanges and other tax-deferred investments may be one component in building your sound financial future.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.