More than half of U.S. households are now making inheritance plans. If you’re among them and stand to inherit property in Pennsylvania, congratulations! However, receiving inherited property comes with understanding the tax implications.
One key area to navigate is capital gains on inherited property. You need to be aware of the potential tax burden you may face if you want to sell the inherited property. However, navigating capital gains tax implications can feel overwhelming.
Luckily, we can help. Below is a guide on everything you need about capital gains on inherited property in Pennsylvania. Keep reading to learn more.
What Is an Inherited Property in Pennsylvania?
Inherited property refers to any assets passed down to you by a deceased loved one — usually outlined in a will. If you inherit property in Pennsylvania, there are legal and financial tasks you must undertake. These include:
Step 1: Complete Probate
You must undergo the probate court. This court ensures the will is valid and oversees the distribution of assets to heirs. It usually takes 6 to 9 months to complete.
Step 2: Assess Your Property
After probate, consider getting a professional inspection or appraisal to evaluate the property. These experts will look at the property’s foundation, structure, and electrical wiring.
Step 3: Clear Debts and Liens
Before selling the property, you’ll need to settle any outstanding debts on the property. These debts include mortgages or unpaid property taxes.
Step 4: Sell Property
After completing the necessary legal and financial tasks, you can sell the inherited property. It may involve finding a real estate agent, listing the property, and negotiating with potential buyers.
Remember, selling inherited real estate in Pennsylvania involves complexities. You may have to deal with outstanding debts and capital gains tax implications.
What Are Capital Gains on Inherited Property?
Capital gains tax on inherited property is the tax you pay on the profit made from selling the asset. When you sell the property, your whole profit isn’t taxable. Instead, you’re taxed on the property’s sale price minus its fair market value at the time of inheritance.
Pennsylvania does impose a capital gains tax on inherited property. When you sell inherited property in PA, you’ll need to report the sale on your state tax return. But here’s the good news — inheriting property gives you a special tax benefit called a “stepped-up basis.”
The IRS resets your property’s basis to its fair market value on the date you inherited it. This means you only pay taxes on any appreciation that happens after you become the owner.
Additionally, PA inheritance tax may also come into play. Unlike the capital gains tax, this tax will be levied on the transfer of property from a deceased person to their heirs.
Types of Capital Gains Tax on Inherited Real Estate Property
Navigating capital gains tax can be confusing. However, understanding the basics can save you a lot of money. Here’s a simple breakdown of the types of capital gains tax on real estate property.
Short-Term Capital Gains Tax Rates
If you sell your property within a year of inheriting it, the profit you make is subject to short-term capital gains tax (STCG). This tax rate is the same as your ordinary income tax rate — ranging from 10% to 37% — depending on your income level. Here is the federal income tax bracket for tax year 2024:
10%: Single: $0 – $11,600; Married Filing Jointly: $0 – $23,200; Married Filing Separately: $0 – $11,600; Head of Household: $0 – $16,550
12%: Single: $11,601 – $47,150; Married Filing Jointly: $22,201 – $94,300; Married Filing Separately: $11,601 – $47,150; Head of Household: $16,551 – $63,100
22%: Single: $47,151 – $100,525; Married Filing Jointly: $94,301 – $201,050; Married Filing Separately: $47,151 – $100,525; Head of Household: $63,101 – $100,500
24%: Single: $100,526 – $191,950; Married Filing Jointly: $201,051 – $383,900; Married Filing Separately: $100,526 – $191,950; Head of Household: $100,501 – $191,950
32%: Single: $191,951 – $243,725; Married Filing Jointly: $383,901 – $487,450; Married Filing Separately: $191,951 – $243,725; Head of Household: $191,951 – $243,700
35%: Single: $243,726 – $609,350; Married Filing Jointly: $487,451 – $731,200; Married Filing Separately: $243,726 – $365,600; Head of Household: $243,701 – $609,350
37%: Single: $609,351+; Married Filing Jointly: $731,201+; Married Filing Separately: $365,601+; Head of Household: $609,351+
In case you’re in a higher income bracket, you’ll pay more in taxes on your short-term gains. This means you may have less money left over after selling the property.
Long-Term Capital Gains Tax Rates
When you hold onto your property for more than a year before selling, your profit is considered a long-term capital gain (LTCG). This is generally taxed at a lower rate. For 2024, the long-term capital gains tax rates are 0%, 15%, or 20%, depending on your taxable income and filing status.
Let’s look at the federal long-term capital gains tax rates for tax year 2024:
0%: Single: $0 – $47,025; Married Filing Jointly: $0 – $94,050; Married Filing Separately: $0 – $47,025; Head of Household: $0 – $63,000
15%: Single: $47,026 – $518,900; Married Filing Jointly: $94,051 – $583,750; Married Filing Separately: $47,026 – $291,850; Head of Household: $63,001 – $551,350
20%: Single: $518,901+; Married Filing Jointly: $583,751+; Married Filing Separately: $291,851+; Head of Household: $551,351+
Understanding these rates is crucial for planning your investment strategy and minimizing tax burden.
How Does Capital Gains Tax on Inherited Real Estate Property Work?
Capital gains tax is a tax on the profit you make from selling property. When you inherit property, the IRS applies a “stepped-up basis” to that asset. This resets its value to the market price on the day you inherited it.
As a result, you can reduce the capital gains tax you owe when you sell the property. For instance, your parents bought their house decades ago for $50,000. Over the years, the value of the house has increased to $800,000.
If they sold it while still alive, they may owe capital gains tax on the $750,000 profit. Here is a breakdown of the calculation:
Original Purchase Price (Cost Basis): $50,000
Current Market Value (Sale Price): $800,000
Capital Gains: $800,000 – $50,000 = $750,000
Instead, if you inherit the house, the IRS steps up the cost basis to the current market value at the time of inheritance. So, the new cost basis becomes $800,000. If you sell the house immediately, you may owe no capital gains tax.
Here’s a calculation with a stepped-up basis:
Stepped-Up Basis: $800,000
Sale Price: $800,000
Capital Gains: $800,000 – $800,000 = $0
However, if you decide to sell the house later for a higher price, you would only be taxed on the gain above the stepped-up basis.
How Holding onto Inherited Property Affects Capital Tax Gains?
Let’s say you decide to hold onto the $800,000 inherited property for a year. During this time, its value increases to $900,000. If you sell it after this period, you’ll owe capital gains tax on the $100,000 increase in value.
Here’s a calculation after one year:
Stepped-Up Basis: $800,000
Sale Price: $900,000
Capital Gains: $900,000 – $800,000 = $100,000
Remember, any improvements or renovations you make to the property can be added to the stepped-up basis, potentially reducing your future tax liability.
How Jointly Inherited Property Affects Capital Tax Gains?
If you inherit property jointly, capital gains tax is split based on each owner’s stake. For instance, if you and your sibling inherit a house worth $800,000 equally, each of you gets a $400,000 share as your stepped-up basis. When you sell, your capital gains tax is calculated based on your share.
Understanding how these tax rules apply to your specific situation is crucial for effective financial planning. It is always recommended to consult a tax professional for personalized advice on inherited property and capital gains tax implications.
How to Avoid Capital Gains Tax on Inherited Property
Inheriting property can be a mixed blessing, especially when you consider potential tax implications. However, there are property tax strategies to get more out of the property sale. Let’s explore ways of minimizing the tax burden.
Sell Immediately to Freeze Gains
One strategy for avoiding capital gains tax on inherited property is to sell it soon after inheriting. When you do so, you lock in the property’s value at the time of inheritance.
For example, if your parent’s home is valued at $250,000 when you inherit it and you sell it right away for the same amount, you may not owe any capital gains tax. This approach works well if your focus is on maximizing immediate liquidity.
However, selling immediately may not align with your long-term plans. This is if preserving the property’s sentimental or practical value is important to you or your family.
Make the Inherited Property Your Primary Residence
Another effective way to sidestep capital gains tax is to move into the inherited property and make it your primary home. The IRS offers a substantial tax exclusion for homeowners who meet certain criteria.
For single filers, up to $250,000 in capital gains can be excluded from taxation upon the sale of a primary residence. This exclusion doubles to $500,000 for married couples filing jointly.
To qualify, you must reside in the property for at least two out of the five years before the sale. This allows you to potentially avoid capital gains tax. It also gives you a period of adjustment before deciding on the property’s long-term future.
Rent Out the Property and Use 1031 Exchange
If selling the property immediately or making it your primary home isn’t feasible, you can rent it out. Renting out the inherited property allows you to defer capital gains tax while generating rental income.
Remember that rental income itself is subject to taxation. However, you can defer paying capital gains tax on the property by using a 1031 exchange.
A 1031 exchange enables you to reinvest the proceeds from the sale of one investment property into another similar property. As a result, you can defer capital gains tax until a future sale of the replacement property.
This strategy can be a powerful tool for preserving inherited property value over time. However, it needs careful planning and adherence to IRS guidelines.
Gift the Property
When you sell a property for more than you bought it, you owe capital gains tax on the profit. However, gifting the property to your spouse before selling bypasses this as you technically never make a sale. Remember to check out the gift tax implications before you proceed.
Disclaim the Inheritance
Want to avoid the complexities of managing inherited property altogether?
There’s an unconventional yet viable option — disclaiming the inheritance.
When you formally disclaim your right to inherit, you pass the property to the next eligible beneficiary without assuming ownership. This decision must be quickly made.
You must also have a full understanding of the legal and financial implications. Remember, once you disclaim your inheritance, you can’t reclaim it. Ensure you weigh your decision against your long-term financial and personal goals.
How to Report the Sale of Inherited Property on Your Tax Return
Did you inherit a house from a beloved relative and want to sell it? Let’s break down how to report inheritance to the IRS.
Step 1: Calculate Your Capital Gain (or Loss)
When you inherit property, its value is “stepped up” to its current fair market value. This means the starting point for calculating your gain or loss is not what the person who left it to you paid. Instead, your gain or loss will be what it was worth when you inherited it.
Step 2: Report the Sale on Schedule D
Once you’ve calculated your gain or loss, you’ll need to report it on IRS Schedule D. Think of Schedule D as your report card for the IRS on how your investments. You’ll need to fill out Form 8949, which is part of Schedule D.
This form details the sale of your inherited property. Ensure to include the date you inherited the property and the date you sold it.
Step 3: Transfer the Gain (or Loss) to Form 1040
Since you’re reporting a capital gain, you can’t use the simpler 1040EZ or 1040A forms. You’ll need to fill out the long form 1040. The good news is Form 8949 conveniently transfers your capital gain (or loss) amount to the appropriate spot on your 1040.
Step 4: Don’t Forget to Attach Schedule D
Finally, ensure you attach Schedule D to your Form 1040 when you file your tax return with the IRS. This informs them about the sale of your inherited property and the capital gain you reported.
Master Capital Gains on Inherited Property in PA
Understanding capital gains on inherited property in PA can help you make informed financial decisions. As a result, you can reduce your tax burden. Remember, each case is unique, and consulting with a tax expert can ensure compliance with local regulations and minimize tax implications.
Need help with the sale of inherited property? Look no further than Pittsburgh Cash Home Buyers LLC. Our professional buyers can help you find the best deal that reduces your tax liabilities.
Reach out to us to learn more.