If you sell an inherited home, you have to share the news with Uncle Sam because you'll owe income taxes if you have a gain, or made a profit. However, a loss could allow you an income tax deduction. Figuring your gain or loss on the sale depends on when the decedent died and how you used the home.
Taxation of Gains or Losses
The sale of an inherited home is treated as a capital gain or loss for income tax purposes. Capital gains or losses are those you realize from selling things you use for personal or investment purposes, such as a house, stocks or furniture. Usually, you have to hold property for at least one year to qualify for the lower long-term capital gains rates. However, no matter how long you have owned an inherited home, any gain or loss is treated as a long-term gain or loss.
Losses from personal property cannot be claimed as a deduction on your taxes. Therefore, if you used the inherited home as your own residence, it becomes personal property, and as such, so you cannot deduct a loss on the sale.
Reporting the Inheritance
The executor of the estate may have to file an estate tax return to report the inherited property. For all years, the executor only has to file if the estate exceeds the exemption amount, which is indexed for inflation, or to preserve the remaining exemption for the decedent's spouse. For 2010, an estate tax return is also required when the decedent's non-cash assets exceed $1.3 million to show the allocation of the additional basis.
The "basis" of the home is the amount used to determine your gain or loss on the sale. The higher the basis, the lower your taxable gain from the sale. If you bought the home, the basis would be the amount you paid for it. For example, if you sell a property for $300,000 and you paid $250,000, your basis is $250,000 and you would only have a $50,000 taxable gain. However, different rules apply to figure the basis when you inherit a property because the tax code allows a special basis step-up.
Determining Your Basis
The basis of the inherited home depends on when you inherited it. In most years, your basis for the inherited home is the fair market value on the date the decedent died. However, for decedents dying in 2010 only, the adjusted carryover basis was used instead because the estate tax was repealed for the year. This adjusted carryover basis applies no matter what year you sell the home. The adjusted carryover basis gave the heir a basis equal to the smaller of the fair market value or the decedent's basis for the home, plus any of the adjustment allocated to the home.
In 2010, the executor of the estate could allocate up to $1.3 million to increase the basis of inherited property, up to the fair market value of the property. The allocation is up to the executor of the estate. For example, if the decedent owned four houses, each of which has increased substantially in value, the executor could increase the basis of any one house by up to $1.3 million or could spread that 1.3 million evenly — $325,000 each — over the four houses.
For example, if the decedent had a basis of $100,000 and a fair market value of $350,000, for decedents dying in any year but 2010, your basis for the home would be $350,000. For decedents dying in 2010, your basis would be $100,000 plus the amount of the basis increase used on the home, up to a total of $350,000. For example, if the executor didn't allocate any of the $1.3 million to the inherited house, your basis would remain at $100,000.
Reporting the Sale
When you sell the home, you have to report it on your income taxes. First, calculate your gain or loss by subtracting your basis from the amount you receive from the sale. Then, report the sale on IRS Schedule D, the form used to document capital gains and losses. Finally, copy the gain or loss over to your Form 1040 tax return. You have to use Form 1040, not Form 1040A or Form 1040EZ, in the year you sell the inherited home.
- Internal Revenue Service: Ten Important Facts About Capital Gains and Losses
- Bankrate.com: Estate Tax Elimination Could Cost Heirs
- Thomson Reuters: The Modified Carryover Basis Rules: "Oh, What a Tangled Web We Weave!"
- Bankrate.com: Reporting the Sale of Inherited Property
- Internal Revenue Service: Form 706 Instructions
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."