When you inherit real estate and then subsequently sell that real estate, you will likely benefit dramatically from the step-up in basis, aka the step-up in basis or the stepped up basis.
There are important tax considerations and a professional advisor may be warranted.
The step-up in basis, what does this mean? If a child or grandchild later sells a gifted or inherited home, they may have to pay capital gains taxes depending on a variety of factors. If a property is inherited, there is a “step-up” in basis of the value of the property (to the value at the time of death) for purposes of calculating capital gains when the property is later sold. The “step-up” essentially provides a higher value of the property when calculating any “gains” as compared to the sales price. The “step-up” can have enormous tax benefits for the heirs that will be lost by gifting property during lifetime.
Gifting Example 1 – Without a Step-Up In Basis
For example, a property was purchased by a parent or grandparent for $1,000,000 and, at the time of their gifting the property, was worth $3,000,000. Five years later, the property is now worth $4,000,000 and the child or grandchild who was gifted the property sells the property for $4,000,000.
There will be capital gains on $3,000,000 of “gains”, i.e. the sale price minus the original purchase price ($4,000,000 [sale price] – $1,000,000 [purchase price] = $3,000,000 [“gains”]).
Inheritance Example 1 – With a Step-Up In Basis
For example, the same property was purchased by a parent or grandparent for $1,000,000 and, at the time of their death, was worth $3,000,000. Five years later, the property is now worth $4,000,000 and the child or grandchild who was gifted the property sells the property for $4,000,000.
There will be capital gains on only the $1,000,000 of “gains”, i.e. the sale price minus the value of the property at the time of death, not based upon the original purchase price. ($4,000,000 [sale price] – $3,000,000 [value at time of death] = $1,000,000 [“gains”]).
This is the “step up in basis.”
Under this example, gifting of the property will cause the child or grandchild to pay tax on an additional $2,000,000 of capital gains.
See the official IRS publication here:
-Devin Lucas
Author Devin R. Lucas is a Real Estate Attorney, Real Estate Broker and REALTOR®, specializing in Newport Beach, Costa Mesa and Orange County, serving individuals, investors and Trustees in real estate.
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