If you inherit a house, you may end up paying some taxes, but the value of the home is never considered taxable income, exactly. If your parents leave you a $300,000 home, for example, you don't report an extra $300,000 in income on your 1040. Instead, depending on where you live and the circumstances surrounding your inheritance, you may have to deal with inheritance tax and estate tax. You may possibly also owe capital gains tax if you sell the property.
As of 2013, unless the deceased's estate is worth at least $5.25 million, there's no federal estate tax to pay. If the deceased was your spouse, there's no federal estate tax no matter how much you inherit. Some states impose estate tax, mostly on estates worth $1 million or more. In any case, as the heir, you're not liable for paying the tax. If the executor has to sell some of the assets to pay estate taxes or other debts, though, that could include selling the house.
Seven states, including Kentucky and Maryland, hit residents with an inheritance tax. If you don't live there but the deceased did, or the house you inherited was there, you're still vulnerable. The amount of tax depends on how closely related you were to the deceased: spouses are exempt, children typically get low rates, and more distant relatives or friends feel the full impact. Unlike estate tax, inheritance tax comes out of your pocket.
Capital Gains Tax
The real tax bite doesn't kick in unless you sell the house and owe capital gains tax. You pay the tax on the difference between the value of the house when you inherit it and what you get when you sell. The deceased's executor will probably figure out the value as part of her duties, so you won't have to guess. If you move into the house instead of selling, you only have property taxes to worry about for now.
Inheritance vs. Gift
If the deceased decides to give you the house before he dies, that's not such a good deal. If you sell a gift house, you measure your gains in comparison to his purchase price, which may be much lower than the home's value when he died, especially if he lived there a long time. If your parent takes out a life estate -- gives you the house but reserves the right to stay until he dies -- your gain is based on the death-date value.
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