Inherited Properties and Tax Basis

Basis is the fair market value of the inherited property to figure gain or loss for tax purposes.

Basis is commonly used to refer to the cost plus expenses of an investment. If you sell an asset for more than your basis you have a taxable gain. If you sell an asset for less than your basis then you have a capital loss which can be used to reduce your taxable income. In terms of real property (real estate), the basis of a home you buy or build is the price you paid, plus any improvements you make while you own it.

For a simple illustration, if you purchased a home for $300,000 and added another bedroom valued at $30,000 while you owned the property, your basis would be $330,000. If you sell the property the following year at fair market value of $400,000 then your capital gain would be $70,000.

What happens though when you inherit property through a probate or trust? Because there wasn’t any “cost” to you, the basis is “stepped-up” which means that the home’s value for tax purposes is not what the decedent paid for the property but is instead re-valued at fair market value at the date of the prior owner’s death.

For example: Bob inherits a house from his father. His father paid $200,000 for it many years ago. During the time his father owned the property he invested $30,000 in improvements which added to his basis in the home for a total of $230,000. When Bob inherits the home the basis is stepped-up to fair market value $600,000 (an appraiser uses market data to determine the fair market value). If Bob sells the house, his taxable gain will be anything above the stepped up basis of $600,000

Another important note about taxable gains from inherited property is that gains are classified as long term capital gains. It’s prudent to make sure your team of advisors are aware of these tax treatments and know how to apply tax reduction strategies to preserve the inheritance for the heirs.