How will selling a house from an estate impact my taxes?

Chad Bice | January 20th, 2011

Dear Drebit:

My mother passed away October 30, 2009. She left my brother and me her house, which has just been released from probate court. We have someone wanting to buy it and we would split around $140,000. What kind of taxes do we face? The house is in SC. I would appreciate your help.

When you sell inherited real property, you may have income to report from the sale. Typically, the gain on the sale is taxed as a long term capital gain on your federal tax return for the year of sale. The general rule based on date of death in 2009 is the basis for the real estate would be stepped up or stepped down to its fair market value at the date of decedent’s death.

For example, let’s say the house was worth $100,000 at mother’s death (establishing the basis) and the heirs sold it for $140,000. The difference of $40,000 would be taxed to the heirs as long term capital gains.

This is the general rule and there are many factors that could alter the treatment. For example, the real estate may have a basis determined on the alternate valuation date (six months after date of death) or the house might have been owned in a manner that would not have received a stepped up basis at decedent’s death.

You might be able to offset at least some of the amount of long term capital gains with capital losses incurred during the year. Since the federal tax code limits the amount of capital losses you can claim to $3,000 during any year, you might also check to see if you have unclaimed losses from prior years that you can use to offset the gain on the sale of the inherited property to lessen your tax burden.

Alternatively, if you already have substantial capital gains or ordinary income for the year, when you add the income from the sale of your inherited property, you could be placed into a higher tax bracket, lose some of your itemized deductions because of phase out rules, or even become subject to alternative minimum tax.

Another consideration for the heirs will be state tax liability. Many state tax laws will tax the income from the inherited property in a similar manner to any other taxable income. Unfortunately, since we are an Ohio firm, we are not familiar with South Carolina’s income tax law.

At the very least, the heirs will need to know the basis in the property they inherited. The accountant or attorney for the estate will have this information. With this information in hand, we recommend that you work with your attorney and tax advisor to fully explore the impact of this sale to your specific tax situation.

Warning: If the date of death was in 2010, the answer to this inquiry could change substantially!

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