Paying Estate Tax and Capital Gains Tax
Heirs worry they could face double taxation and pay more estate tax and capital gains tax when selling to a relative
Q: I have enjoyed your columns for many years and have a question about how to avoid overpaying estate tax and capital gains tax. We have a situation where both of my in-laws passed away in the last several years. My wife was the daughter and she and her brother are the executors to the last of my in-laws to pass away.
The estate includes a small house recently appraised at $220,000. We have several plans for the home once it is out of the estate. One scenario would be that our 30-year-old son would purchase the house from the estate. If he can’t qualify to buy it, our second scenario would be that my wife and I would purchase the house and rent it to him. Down the road, he can buy it from us.
Paying estate tax and capital gains tax in sale of house
What steps should we take to help him buy the house from us? What tax strategies should we use to minimize estate tax and capital gains tax that would occur through these purchases?
A: We need to make sure we preface some issues given your question. You mentioned that the last of your in-laws died a while ago and that the home is in trust. Your in-laws put the home into the trust to make it easier for your wife and any other heirs to sell or transfer ownership of the home.
If you sell an inherited home within a year, there should be no capital gains tax to pay
The property can remain in the trust, but the home effectively is no longer owned by your in-laws. Rather, it is owned by the beneficiaries of the trust. We assume your wife and her sibling are the beneficiaries that would now own the home.
The date your in-law passed away is important. Let’s assume your mother-in-law was the last to die, and she died in 2022. If the property was worth $100,000 at the time of her death and the value has now increased to $220,000, the sale to your son would trigger a tax on the $120,000 profit. Ordinarily, if you sell a property within a year of the death of the property owner, the value of the property at the time of the death will be assumed to be identical to the amount of the sale. In this situation, there is no federal taxes to pay on the sale as there is no profit.
Avoid double taxation: strategize to minimize estate tax and capital gains tax
Now, let’s turn to the question about your son buying the property. Can he qualify for a mortgage and purchase the home for the appraised amount of $220,000? If so, then you’ll likely avoid taxes from the trust side. This is especially true if the date of your mother-in-law’s death was within the last year or you have documentation that shows that the home had a value of $220,000 at the time of her death.
Now, let’s flip the script. Let’s say your son can’t qualify and you decide to rent the property to him. Then, the property becomes an investment. Your wife and her sibling will enjoy the tax benefits of depreciation, have the ability to deduct any real estate taxes, deduct other expenses and take the rent as income. If and when your son ends up buying the home, your wife and her sister will have to pay taxes on the profit from the sale of the home — if the home appreciates in value — and will have to repay the depreciation benefit they received while they owned the home as an investment property.
Installment sale could minimize capital gains tax
You might consider two other options: First, consider allowing your son to buy the home on an installment basis; second, or have him pay some money down now and you take back a mortgage. With either of these options, your son would own the home and get the benefits of homeownership. Along the way, your son would make payments to your wife and her sibling and gain equity in the home. When your son’s credit is at a point that he can obtain financing, he can pay off the balance on the installment contract or mortgage owed to your wife and her sibling.
One thing that you should explore is whether you or your late in-laws have any income or estate tax issues. Under Federal estate tax laws, we suspect you don’t have anything to worry about if the estate was below the $12,920,000 exemption (if the last inlaw died in 2023). Generally, this means that if the deceased had an estate of less than that amount, the estate would have no federal estate taxes to pay. However, some states have a state estate tax or other fees on assets left in an estate. Please check with your tax preparer, accountant or an estate attorney.
Use an attorney to draft up paperwork so you don’t run afoul of the IRS
And, whether you decide to rent or sell the property to your son, you’ll want to hire an attorney to draft up the paperwork. As your wife doesn’t own this property on her own, you will want to document everything, so all beneficiaries can rest assured that you’re handling the situation correctly.
Read more about inheritances, and paying estate tax and capital gains tax:
Leaving Real Estate to Children
Capital Gains Tax on Inherited Property?
©2023 by Ilyce Glink and Samuel J. Tamkin. Distributed by Tribune Content Agency. A1597
I am a widower with a natural Daughter, and two step Children in their forties. I have a will that designates My Natural Daughter as my Executor. I have indicated that I want to have each have an equal share of my assets. The only significant inheritance would be my house. Is there a way in which I could include my Children on my Deed or another document that will allow them to not have to pay an inheritance tax on the house for any property gains since the house was bought 30 plus years ago, and is valued at significantly more currently. I paid $152,000 in 1993 and the state property taxes are currently for +$400,000.I do not have a significant Money in any accounts other that my property to leave to my children. Can I frame my intent legally so that they will have as much as I can leave them?
James:
If you leave the property to your children (step and natural) they will receive the step-up basis. That means, the cost basis of the property will “step up” to the market value on the day of your death. If your children turn around and sell the house within a year, it’s deemed to have been sold at whatever the market value is as of the day of death – so, no taxes to pay.
So, even if you paid $150,000 for the house, they will inherit it at the value as of the day you die. Let’s say that’s $400,000 or even $4 million. To the IRS, that is the value. If they then sell it for $4 million, there is no “profit,” so no tax owed.
Hope this helps. I’ve written a lot about this on ThinkGlink.com. You can also look at the IRS website, Publication 523: selling my home.
Ilyce