By: Matthew M. Shafae, Attorney
Litherland Law Firm
Am I going to owe taxes if I inherit property?
We get this question all the time. And we don’t blame you. It can get confusing. So, let’s see if we can clear up this issue. Let’s segregate the different taxes that might be owed, and then we can see if anything will be owed.
The estate tax—or death tax, as it’s sometimes called—is a transfer tax on assets transferred from someone who died to someone who is living. The tax applies to everything the dead person owned before dying. Most of the time, the estate pays this tax, and not the beneficiaries. There’s also some more good news. The IRS gives everyone a freebie—an exemption. If someone dies owning less than $5 million ($5,000,000), then no tax is owed. And that number is increased a little every year. So, if you die in 2017, then you can own up to $5.49 million ($5,490,000) and not have to pay this tax. For married couples, you can effectively double that amount. That means that a married couple can own up to $10.98 million ($10,980,000) and not have to pay this tax after the second spouse dies. For those lucky few who own more than the exemption amount, that estate will be subject to a 40% flat tax for every dollar more than the exemption amount.
A few things to note: there is no California estate/death tax. It is a federal tax only. The year in which you die, and the county in which you resided, will dictate the exemption amount and laws that apply to your death.
Capital Gains Tax (Income Tax)
Capital gains taxes are a form of income tax. It is a tax on the profit made on an asset after the asset is sold. For example, if I bought a home for $100, and sold it for $500, then I have a capital gain of $400. I will be taxed on that $400 after I sell the home. That’s right, capital gains are only recognized once an asset is sold. So, you can have an asset with substantial gains built into it and never owe taxes before you sell that asset. Now, if you want to be clever and think that you can gift the asset during your life and not pay capital gains, then you’re half right. You won’t pay the capital gains, but whomever sells the asset will eventually pay the gains based on the price for which you bought the asset.
Why is this relevant to estate planning? Great question. The Internal Revenue Code (the statutes that the IRS enforce) provides that when someone dies, all of the capital gains built into all of that person’s assets are eliminated. Yes, you read that correctly. The gains are wiped out. Remember how I just said that if you gift an asset during your life, that the recipient of that gift must pay the taxes if they sell the asset? Well, if that same person received the asset as an inheritance, and not a lifetime gift, then there will be zero capital gains built into that asset. This is also called a “step up in basis to fair market value on the date of death”.
This capital gains rule applies differently depending on how the asset is owned. For example, this rule is different if the asset is in an irrevocable trust, or if it owned as joint tenancy. It’s important to discuss these issues with competent tax professionals (like us!).
Property tax is a tax on real estate ownership. It is imposed by the county where the real estate exists, and must be paid by the owner of the real estate. In California, the tax is a percentage of the assessed value of the property (usually the price for which you purchased the property) and it only gets reassessed when there is a change in ownership. One exception to the reassessment rule is if the transfer is between parents and children. In that case, there is no reassessment. The exception applies differently if the property is your primary residence or not, so please discuss this issue with competent tax professionals before transferring property.
If you inherit real estate, and the person who left it to you is your parent or child, then you likely will experience no change in property taxes. If the property is sold and you receive proceeds of that sale as an inheritance, then there will be no property taxes on that inheritance since there is no longer any property. You now own cash.
Whew, you made it! You can see that if you inherit property from someone, and you reside in California, then you’ll likely owe zero in taxes because of that inheritance. There are, of course, exceptions to that general statement. If you would like to discuss your situation, please contact us for a free consultation at (408) 356-9200 or (831) 476-2400 or by clicking here.
- Reasons an Estate Plan Could Be Challenged: Part 1 – Formal Requirements - January 24, 2020
- Estate Tax Exemption Amounts to Increase - November 6, 2019
- Beneficiary Designations, etc., Aren’t a True Substitute for a Trust - March 6, 2019