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What is the cost basis for inherited property?

| Jan 4, 2021 | Tax Planning |

There are few if any universal truths when it comes to estate law. However, whether you are currently in the process of working through an inheritance or you are planning for your own family’s future, tax is likely to be a major concern.

When it comes to selling property, cost basis is an important concept — and one that applies to inheritance in a potentially surprising way. By way of review, cost basis is, in simple terms, the dollar amount you pay when acquiring an asset.

Estates

As explained by the IRS, there are two common options for calculating the basis of an asset you inherit. The first would be taking the fair market value at the time of the decedent’s death. The second and more complex option would be selecting another date on Form 706, the estate tax return.

In most cases, this means that your cost of acquisition becomes the fair market value at the moment you inherit the property. It effectively resets your basis.

Standard transactions

Why is this important? To understand that, take a look at how cost basis usually operates.

In a simple transaction, you would calculate capital gains tax based on income — gains or losses. For example, if you paid $100 for an asset and sold it for $1,000, you would have a $900 taxable gain.

Sales of inherited property

It is much different for estates. Imagine your loved one paid $100 dollars for an asset, and it was worth $1,000 at the time you inherited it.

A few years later, you sold it for $1,200. With the new basis, your taxable gain would be $200. This is far less than the $1,100 actual appreciation over the course of your family’s ownership. You would, therefore, probably pay less in tax.

Tax strategies

Cost basis is important. However, it just one of the factors that could change the amount of tax liability you or your heirs might have on the sale of inherited property.