What to do when you Inherit Real Estate (How to save on Capital Gains Taxes)
In my appraisal business, I often do appraisals for heirs that have inherited real estate. The reason for the appraisal is to establish a stepped up tax basis to reduce taxes for capital gains if the property is sold. If you inherit a real estate, it is very important that you have a real estate appraisal completed as of the date of inheritance. This is also known as a date of death appraisal report, which is a grim description, but the date of passing is the date that the heirs take ownership of the real estate.
Consider this scenario, as a way to explain how this report will be extremely beneficial to the heirs for tax planning:
Jerry buys a house in San Francisco for $100,000 in 1965. Jerry passes away on August 9, 1995. Jerry leaves his house to his brothers Bobby and Phil. Bobby and Phil go to an attorney and a financial planner that both advise that an appraisal be prepared as of Jerry’s date of death. The appraisal report reveals that Jerry’s property was valued at $750,000 as of August 9, 1995. Jerry’s brothers decide to sell the house two years after they had inherited it and it sells for $860,000.
It’s a good thing that Bobby and Phil had an appraisal done because their tax liability is $110,000 for the gain from the time that they inherited Jerry’s house ($860,000 sales price minus $750,000 home value as of date of inheritance=$110,000). The two brothers may have had capital gains of $760,000 if they did not complete the appraisal for stepped up tax basis. ($860,000 sales price minus the $100,000 price that Jerry had paid for the house 30 years earlier).
When to get an appraisal for Stepped Up Tax Basis
An appraisal for stepped up tax basis may be completed at any time after inheriting a property. It is easier for an appraiser to complete the report if you request it soon after inheritance. The report can be completed years after inheritance, but it is considered to be a retrospective forensic appraisal and the report may cost the heirs more. I recently completed a retrospective appraisal report for a client that sold their house in 2015, but inherited it in 1995. It is possible, but the data available to the appraiser becomes limited over time.
What do I do if my spouse passes away and we own property together?
It is also important to know that in the case of a married couple, if one spouse passes away, the surviving spouse is eligible for a stepped up tax basis to reduce capital gains taxes. The surviving spouse in a married couple that has been in their Orange County home for a long time would have a large increase in appraised value which would reduce capital gains taxes significantly upon the sale of the home.
This example illustrates how a spouse can reduce capital gains tax:
Mom and Dad buy their home for $50,000 in 1967. Dad passes away in 2007 and the home appraises at $900,000 as of the date Mom inherited the property. Mom assumes a stepped up tax basis of $900,000 and sells the house for $900,000 shortly after Dads passing. Mom owes zero in capital gains taxes.
Moral of the Story
The moral of this story is that after inheriting a property, an appraisal should be completed. There are many arrangements to be made during these unfortunate times. The appraisal should not be at the top of the list, but should be completed within a reasonable time after inheritance. The benefits of the appraisal will reveal themselves when the house is sold in the future and the tax burden is reduced.
If I can help by completing an appraisal for estate and tax planning purposes for inherited property, contact me at CMP Appraisals (949) 388-4943 or via email email@example.com