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Does an Inherited Property Generate a Tax Bill?

Published August 16, 2017 by Brady Cobin Law Group, PLLC

There are certain tax savings to leaving the family home to members of the family. They gain what is called a “step-up in basis.” Here’s how it works.

Inheriting real estate is a little different than other assets. When members of the family inherit property, usually the family’s primary residence, they learn about the property’s cost basis. It sounds more confusing than it really is.

There are a couple of issues to understand in this scenario, says NJ.com in “Figuring cost basis for an inherited home.” When an appreciated asset is inherited, the person who inherits the asset gets a step-up in basis. This simply means that the appreciation in the property that took place during the deceased person’s lifetime, isn’t attributed to the person inheriting the asset.

If we assume that a husband and wife owned real property that appreciated in value, the surviving spouse would receive a step-up in basis at the death of the first spouse on the one-half interest of that deceased spouse.

When the second spouse dies, the children who have inherited the property also get a step-up in basis for the entire property equal to the fair market value (FMV) of the property as of the date of the death of the second spouse.

Here’s a quick illustration:

A husband and wife purchased real property for $400,000. They don’t make any improvements to the home. When the husband passes away, the fair market value of the property is $500,000. That’s an appreciation of $100,000. The wife receives a step-in basis of the husband’s 50% interest in the property. That interest is now valued at $250,000. In addition, the wife also retains her cost basis in the property ($200,000, or one half of the $400,000 purchase price) for a total cost basis of $450,000. That would be her cost basis, if she sold the property during her lifetime.

However, if the wife as the surviving spouse retains the property at the time of her death (and the property is still worth $500,000), then the children who inherit it would receive a step-up in basis of $500,000. Therefore, if we say that the property is worth $600,000 at the time of the wife’s death, the children’s step-up in basis would be $600,000.

If you plan to pass the family home to the next generation, it will be helpful to meet with an experienced estate planning attorney to determine the best way to accomplish this for your situation. You might also consider having your family members join in the conversation, so that everyone can be prepared and understand the process.

Reference: NJ.com (July 6, 2017) “Figuring cost basis for an inherited home.”

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