Minimizing Capital Gains When Inheriting Real Estate
Inheriting real estate can evoke a mix of emotions, from fond memories of loved ones to the recognition of a substantial financial asset.
Yet, amid the emotions lies the looming concern of capital gains tax.
Have you ever wondered how to navigate this crossroad effectively?
Don’t worry!
There’s proven legal strategies and valuation approaches to help mitigate the tax burdens and safeguard your inheritance for the future.
You need to research and analyze these strategies and speak with a tax professional to see what will be beneficial to you and your future. Let’s take a closer look.
Understanding Capital Gains Tax
Capital gains tax is a levy on the profits from the sale of assets such as real estate, stocks, and bonds.
It only becomes relevant when the property is sold for an amount higher than its fair market value (FMV) at the time of the original owner's death.
The implications of this tax can be significant but there are strategies to reduce or even eliminate it, such as the step-up basis.
What Is Step-Up Basis?
The step-up basis is a tax provision that adjusts the value of an inherited property to its fair market value as of the date of the original owner's death.
This adjustment usually results in a higher cost basis for the inheritor, minimizing the taxable gain upon selling the property.
California adheres to the current federal tax law regarding stepped-up basis, allowing beneficiaries to potentially reduce or eliminate capital gains tax upon the sale of the property.
Consider this scenario if you sell the home for $500,000, whereas its fair market value at the time of your inheritance stood at $450,000. This results in $50,000 in capital gains.
However, you can lessen this exposure by deducting the closing costs of $40,000, ultimately leaving you with only $10,000 in capital gains.
Strategies To Minimize Capital Gains
Deciding what to do on inherited assets has distinct tax implications, which should be weighed against the potential financial benefits and long-term plans.
Here are a few ways to lower your capital gains tax.
1) Sell the Property Quickly: This initial approach serves to minimize or even eradicate capital gains tax on the inherited asset. For instance, if you inherit a property valued at $400,000 and promptly sell it for the same amount, you won't realize any capital gain.
Furthermore, if the property's value depreciates and you sell it for less than its inherited value, you won't be subject to capital gains tax either.
2) Tax Implications of Keeping the Property: If you choose to keep the property but don’t want to live in it, converting it into a rental may suit your needs.
This option allows you to delay tax payments upon eventual sale by engaging in a 1031 tax-deferred exchange. In this transaction, proceeds from selling one investment property are reinvested in another property.
However, if you opt not to reinvest in another rental property, you'll incur capital gains tax when selling the rental property.
3) Opt out of inheriting the property: You can opt out. To do so, you'll have to sign a Disclaimer, deciding against inheriting the property to avert unfavorable tax repercussions. It's imperative to note that this decision is irrevocable.
These are just some of the strategies available to you to help lower your capital gain. It is always best to speak with a tax professional to make sure you are utilizing the right options to help meet your financial goals and secure your future.
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DISCLAIMER: The content contained herein is for general informational purposes only. These materials do not constitute legal or other professional advice. We do not accept any responsibility for any loss that may arise from reliance on this information. No reader should act or refrain from acting based on information contained in this article without seeking advice of counsel.