Tax Considerations for Inherited Properties: What You Need to Know

If you inherited a property in the last twelve months, you might be wondering about what the tax considerations are for the upcoming tax season.

Most inheritances aren’t considered income for federal tax purposes. What happens next is where it becomes less straightforward. Whether you sell the house, move in, or rent it out will change the tax implications for the property.

In this article, we will look at the tax considerations for inherited property based on federal and state taxes, as well as whether you choose to keep or sell the home. 

Tax considerations for inherited properties when the estate is transferred

There are four main taxes that could apply to an inherited property as part of a transfer of estate:

1. Federal estate tax

Federal estate tax is a tax on the transfer of property at death, taken from the estate. It won’t apply to most estates with a single property, because estates valued at less than $12million are excluded. But if your inheritance includes valuable assets, it may exceed the exclusion amount and need to be filed in an estate tax return. 

The exclusion amounts change year-to-year to account for inflation and are currently:

• 2021: $11,700,000

• 2022: $12,060,000

• 2023: $12,920,000

The tax only applies to the value above the exemption amount, so even if the estate was worth $13million, 28% tax would owe on $80,000. The rules can be complex and there are strategies for reducing what you owe as well as exemptions for surviving spouses, so it’s important to speak to a professional about the best approach for your situation. 

2. State estate tax

If your recently deceased loved one was a resident of Washington, Oregon, Minnesota, Illinois, Maryland, Vermont, Connecticut, New York, Rhode Island, Massachusetts, Maine, Hawaii and Washington, D.C, their estate will be subject to state estate tax. The tax at a state level applies regardless of whether the federal estate tax applies (a double-whammy for larger estates). 

Like the federal estate tax, there are exemption thresholds and varying rates of tax applicable depending on the value of the estate being transferred. These vary from state to state. To see the exemptions and threshold tables, plus forms and FAQs on localized estate tax, visit the link for each state below:

• Washington state
• Oregon
• Minnesota
• Illinois
• Maryland
• Vermont
• Connecticut
• New York
• Rhode Island
• Massachusetts
• Maine
• Hawaii
• Washington, D.C

3. State inheritance tax

Six states in the US have a state-level tax on inheritance, which is different to an estate tax. 

Instead of a tax on the estate, as the recipient of an inherited estate, you will be required to file and pay the tax. 

The amount of the tax payable is based on the local state regulation, the relationship between the decedent and the beneficiary, and the value of the property being inherited. If the decedent was a resident of Iowa, Kentucky, Maryland, New Jersey or Pennsylvania, it’s worth getting professional advice on local inheritance tax. 

See the local state websites for more information and 2023 inheritance tax rates:

• Iowa
• Kentucky
• Maryland
• New Jersey
• Pennsylvania

If you inherit a property or estate in Maryland, be aware that both an estate and inheritance tax apply. 

4. Federal gift tax

What happens if you inherit a home from a loved one during their lifetime? If you are fortunate enough to be given a home by someone before their passing, estate and inheritance tax rules won’t apply, but you could be subject to gift tax on transfers of property. The amount of tax is based on the value of the property being transferred. 

This could also apply if you buy a home for less than market value. For example, if your parents sold you a house for $1 or even $500,000 when the market value is worth $1.5million, this would be considered a gift for tax purposes. This tax is designed to stop wealthy individuals from finding loopholes to paying estate taxes by giving property away. 

The annual exclusion amount for gifts in 2023 is just $17,000 per individual ($34,000 for a couple) — significantly less than the estate tax thresholds. 

Tax considerations for inherited properties when the home is sold

If you inherit a property and don’t wish to move in, you may sell it to pay off your own mortgage or focus on other investments. In this instance, if the home appreciates (rises in value) between when you inherited it and when you sell, you will be subject to capital gains tax on the difference. This is because the inherited home is now considered an investment property, even if you haven’t sought to be a real estate investor. 

The key difference between paying capital gains on an investment home that you have bought vs inherited is the way the value of the home is calculated. When you buy a home as an investor, the home’s cost is the basis for which you need to calculate capital gains. If you inherit a home, the home’s cost is not based on the value the original owner paid for it, but on the market value at the date in which they died. 

This is good news for those inheriting a home. The market value will likely be much higher than the original price, reducing your capital gains tax liability.

If the market drops and you sell the home for less than it was valued at when you inherited it, this can be claimed as a loss with no capital gains payable. When you inherit a home, you should arrange for a current appraisal to ensure that the current market conditions and any home improvements are accounted for to to have a record of the fair market value. Tax applicable can also vary if you sell the home within a year of inheriting it, so it’s important to speak to an accountant or tax professional to find out what will be most beneficial in your circumstance. 

The only way to avoid capital gains tax on selling a property you have inherited is to move in and make yourself at home. There are generous tax exemptions for your primary residence, but you must have lived in the home for at least two out of the last five years — so it’s not a short-term option. You will also need to pay state property taxes and local levies for your new home. 

Tax considerations for inherited properties when the home is put on the rental market

If you don’t want to move into the home, selling is not the only option. Rental demand is high in the US in 2023 and you could achieve passive income from the home by putting it on the rental market.

In this instance, you will need to declare your rental income on tax — but you will also benefit from tax strategies and deductions that will reduce your tax liability. 

Common tax deductions for rental properties include: 

• Property taxes
  
• Homeowner’s insurance premiums
  
• Professional fees for advice and help on your rental property, including accountants, property management or Belong fees, and legal advice
  
• Any utilities you cover on behalf of rental residents, such as electricity, landscaping
  
• Necessary repairs and regular maintenance

You will also be able to claim depreciation on the home and if you sell it to buy another similar investment property, you could be eligible for a 1031 exchange or “like-kind” exchange. 1031 exchanges allow you to defer capital gains tax, giving you more net cash to invest in a replacement property.

Full-service help with your inherited home

Inheriting a home can be emotional, stressful and complex — but help is here. Designed with first-time landlords in mind, Belong will make sure your inheritance works towards your financial goals and freedom. 

This is because Belong is not a traditional property management company, but a residential network offering unique services to both homeowners and their residents. Your family’s home will be cared for by someone who will love it like their own — and you won’t have to lift a finger. 

When tax time comes around, your income and expenses will be simple to calculate because you always know exactly where you stand. With guaranteed rent in place, you will know precisely what your rental income looks like (regardless of when residents pay). And you won’t find yourself getting tripped up by a string of unexpected expenses.