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If you inherited a piece of real property and have, or want to sell it then you should consider the tax consequences.
The sale of real property is a taxable event that must be reported on the seller’s income tax return for the year in which the property is sold. Depending on the value of the basis for the property and the sales price, there may be a capital gain which is taxable at the federal and state capital gains tax rate. A capital gain or loss is determined by taking the sales price of the real property and subtracting the basis plus closing costs (e.g. real estate broker commissions, real property transfer tax, legal fees, etc.). If the proceeds of the sale is greater than the closing costs and basis that amount is the capital gain. If there is nothing left then it is a wash. If the closing cost and the basis are greater than the sales proceeds then there is capital loss.
Usually the seller determines the “cost basis” of the property by taking the initial purchase cost of the property, and adding to that the cost of any capital improvements made to property. However, the rules are different when you inherit real property. If you inherit real property, the basis for the real property is the fair market value of the property as of the date of the death of person you inherited it from. This is called a “step-up in basis” because the fair market value is usually greater than the cost basis of the property, so the basis will “step up” to the higher amount.
However, sometimes the cost basis of the property is greater than the fair market value of the property as of the date of the decedent’s death. Unfortunately in this is the case, you must use the fair market value as of the date of the decedent’s death even though it may be less advantageous.
If you inherited real property that you plan to sell, it may be beneficial to have a certified real estate appraiser issue a certified real estate appraisal on the property in order to determine the fair market value as of the date of death. This will help you determine a fair asking price for the property, but more importantly provide documentation to support your determination of the step up in basis. If you do not wish to obtain a certified real estate appraisal, you may be able to use the purchase price of the real property as stated in the contract of sale depending on when the contract of sale is executed.
By Eric J. Einhart, Esq. – Guest Blogger