A to Z Guide on Real Estate Inheritance and Its Taxation in 2020
Are you under the impression that only those who inherit real estate of significant value feel the tax bite? The odds are stacked in your favor. However, there are exceptions and the particulars of your inheritance circumstances can impact your tax bill.
Don’t get confused between Estate and Inheritance taxes, although it may look similar. There are differences. An Estate tax is paid out of the deceased’s estate whereas the Inheritance tax is paid by the beneficiary of the estate.
What Is Inheritance Tax?
Inheritance tax is a tax that needs to be paid by a person who inherited money or property after the death of a loved one.
The inheritance tax is imposed at the state level in the United States and thus it is your location in the country that basically determines if you fall under the purview of inheritance tax.
The residents of states such as Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania often have to pay inheritance tax; however, there are exceptions, of course.
In cases where the deceased has left behind a spouse and children, being direct descendants, they may receive exemptions from paying any inheritance tax.
However, residents of Maryland and New Jersey can get hit with a double whammy and end up paying estate and inheritance tax together. While it’s an unlikely scenario, it’s still a possibility.
Simply put, the beneficiary pays inheritance tax on the assets and monetary benefits received from the deceased person’s estate. The total amount left behind falls within the accounts of the estate.
The tax is paid on the total value of the assets that they’ve received as an inheritance. It can be complicated to calculate the inheritance tax if you are unaware of the determining factors which are:
- The type of property inherited
- The relationship with the deceased
Those who are direct descendants, for example, a child or a parent, may pay a lower inheritance tax in comparison to those who are not a direct lineal descendant.
If the beneficiary is not related at all to the deceased, he or she ends up paying the highest percentage of inheritance tax.
For example, in Pennsylvania a direct descendant pays 4.5% tax on the inheritance, siblings pay 12% and those not related to the deceased pay a whopping 15%.
You need to do the following in order to find out the rate of inheritance tax that you are liable to pay:
- Get an appraisal of the total value of your inherited assets
- Determine the tax bracket
- Apply any tax exemptions, if eligible
Is Inheritance Taxable?
This is a common question when one is a beneficiary of a property or a trust – “Is inheritance taxable?”. Before we arrive at the answer, one needs to understand what the term ‘taxes’ actually encompass.
In this case, the beneficiary may be liable to pay three types of taxes which are – estate tax, inheritance tax and income tax. To get a comprehensive understanding on whether your inheritance is taxable or not, let’s look at the following:
- Check if the state where the deceased resided, levies an inheritance tax. However, if you inherit real estate in a state where inheritance tax is not levied, you are not liable to pay even if your current residence is in a state that has inheritance tax.
- If you are liable to pay the inheritance tax, check for exemptions. For example, – all the states exempt spouses from the liability of inheritance tax.
On the other hand, Nebraska and Pennsylvania collect inheritance tax if the property is passed on to children and / or grandchildren.
Is Inheritance Considered an Income?
The next obvious question that is asked is if the inheritance is considered as income. Under normal circumstances, inheritance is not categorized as income. But, if the deceased drew an income from the property, you may be subject to some form of taxation.
Check how the income was reported by the deceased in their personal tax returns and the beneficiary should accordingly report the inherited property as income in their tax returns too.
However, if the estate that has been passed on as inheritance, reported it as income on behalf of the deceased, then the beneficiary is not liable to report the inheritance as income.
Who Pays Inheritance Tax?
The inheritance tax is a state level tax applicable in only seven states in the country where the beneficiary of the real estate property is liable to pay the inheritance tax.
How to Avoid Capital Gains Tax on Inherited Property?
There is a way by which one can avoid capital gain on inherited real estate.
Primary Residence Exclusion: This generally implies that if one makes the inherited property their primary residence, in due course of time, they can avoid capital gains tax through selling the property up to $250,000 in case of an individual, or $500,000 for a married couple.
What Happens If You Inherit a House With a Mortgage?
While one may be jumping with joy on inheriting real estate, it can be a financial drain, if it comes along with a mortgage. In many cases, one may have to repay the remaining mortgage amount in a short period of time.
A lot will depend on the relationship between the deceased and the beneficiary of the real estate property and the terms of the mortgage loan originally signed by the deceased.
The majority of mortgage agreements contain a clause known as ‘Due on Sale’ which states that the remaining loan is payable if the borrower transfers the property to someone else.
Upon the death of the original borrower, if the property is left to a beneficiary, that basically constitutes a legal transfer of ownership. With a ‘due on sale’ clause included in the mortgage agreement, the beneficiary may have two options to consider– pay off the entire loan or sell the property.
How to Sell an Inherited House After Death of a Parent?
There are various ways to sell an inherited house. However, if there is a time constrains requiring to get rid of the inherited asset quickly, the fastest way to liquidate the property is to sell it to cash home buyers like House Cashin.
Selling inherited home to cash investors is the best route one can take because:
- Inherited home will be sold SUPER FAST (in matter of days)
- Inherited home will be sold FOR CASH (no financing)
- Inherited home will be sold ‘AS IS’ (in any condition)
How to Determine Fair Market Value of Inherited Property?
IRS views the selling price of the inherited property within a year of the transfer of ownership post the benefactor’s death as a value indicator.
However, if the property is sold at a stark discounted price, way below the market value, possibly to a family member or a relative, the IRS in that case may not accept it as a fair market value of the inherited property.
In such circumstances, the beneficiary selling the property may be slapped with tax on the differential price.
The best way to determine the fair market value of the inherited property is by hiring the services of a professional certified appraiser who may provide an estimate based on the comparative prices of properties in the area.
Alternatively, reputable real estate agents may also be asked to submit an estimate.
How to Divide Inherited House Between Siblings?
Benefactors with the best of intentions may leave more than one beneficiary to a singular real estate property, for example, parents leaving their house to more than one child. In such a situation, the best way to deal with it is by:
- Mutually deciding to liquidate the property
- One sibling may decide to buy out the other sibling’s share of the inherited property
- Siblings may jointly decide to share the property
- Approach the court of law if neither party are able to reach a mutual agreement
How to Buy Out Siblings From an Inherited House?
If a sibling buy-out is on the cards, then the best way to handle the situation is to start by making a plan for the transaction. Adopting a fair and professional approach, follow this step-by-step process:
- Hire the services of a professional certified appraiser to get an estimate of the market value of the inherited property
- Mutually decide with the siblings involved on individual shares and their equivalent worth
- Pay the sibling at the determined value of their share
- Sign a legal binging agreement that transfers the sibling’s ownership right to the buyer
While it may be difficult to keep all emotions at bay during a transfer such as this, adopting this approach will help to keep the sibling relationship cordial and create a sense of peace within the family.
How to Report Sale of Inherited Property on Tax Return?
To report the sale on an inherited property on tax return, ones needs to access Schedule D (Form 1040).
Inheriting property in most cases is not considered income for federal tax purposes. However, if there are any subsequent earnings from the inherited property, there comes in the tax liability, unless the source is tax-free.
Taxes are payable in case one gains from selling the property, on the other hand, one can also claim losses on these sales. The inheritance tax varies from one state to the other.
Therefore, it is best to consult a professional or check the state’s department of revenue, treasury or taxation for more details.