How to Avoid Capital Gains Tax on Inherited Property in San Diego
Dave and his wife, Jacquelynn, called us a few weeks ago because Dave’s beloved mother had passed away, leaving them with an inherited property in North County San Diego. The home was perfectly situated in the rolling hills of Escondido, with sweeping views of the Welk Resort and golf courses nearby. Dave and Jacquelynn held countless fond memories of the good times shared at this house as their children grew up with their grandmother. Dave’s mother took good care of the home over the years, and had a lot of help more recently from the family’s caretaker who lived with her. While everything was neat and tidy, the home did show some signs of aging and could use a “facelift.” Because Dave and Jacquelynn lived in Los Angeles with their children, they were faced with a decision: what will they do with the home they just inherited, and what are the costs associated?
Losing someone you love is painful enough, and having to decipher the estate through probate lawyers etc. can add to the stress. Dave’s mother had kept up with all of her mortgage payments, and the home was actually worth quite a bit more than when she had purchased it over 20 years ago. She purchased the home at $160,000 and it is now valued at $315,000 – what should Dave and Jacquelynn do?
The Basis of Your Inherited Property
There are some tax regulations that dictate whether the money received from the sale of your inherited property is in fact taxable income. Your basis for the inherited asset is the probate’s value for your property. In other words, your profit in selling is calculated from the fair market value (FMV) of the home at the time of your parent’s death. It’s over that FMV basis that you pay for capital gains (not what the home was worth when your parent purchased the property).
Referencing Dave’s scenario above, given this “stepped-up” basis: he and his family do not have to pay on gains from the $160,000, rather the profit over $315,000 (FMV). But, if Dave sold his mother’s house in a year for $350,000, he would have to pay capital gains tax on the $35,000 profit over the fair market value. But, can he avoid capital gains tax altogether? Is that even possible? Living in Los Angeles, he’s not really in the position to rent the house for a year or pay fees for two homes.
Option 1: Move into Your Inherited Home
There is a way to avoid capital gains tax if you want to make a profit on the home you inherited. But, it’s not as simple as you may have hoped. You have to physically live in the inherited property as your primary residence for at least two out of the five years prior to selling. This is possible due to the Home Sale Tax Exclusion.
Who qualifies for the Home Sale Tax Exclusion?
The Home Sale Tax Exclusion is a tax law that gives homeowners a very nice tax exclusion when they sell their homes. But, as mentioned above, the homeowner must have used the property as their main home for at least two years prior to selling. If you are in the position to move into the house you inherited and occupy it for at least two years, you can then sell the house at a gain of up to $250,000 completely tax free.
What to expect if you choose to move in:
- Moving into the inherited house could require relocation and uprooting from your current living situation, which can be both costly and stressful.
- The inherited house may require repairs in order to meet your living standards, which would delay the time in which you could move in.
- You’ll still have to pay taxes outside of capital gains, such as property taxes while you occupy the home. Some states event charge inheritance taxes.
Option 2: Sell Right Away to Avoid Capital Gains Tax
If moving into the inherited property isn’t an option for you, and you don’t want to risk paying capital gains on the property if you wait to sell it in a few years after renting it out – sell the inheritance right away. If you sell your parent’s home immediately after you inherit it, you will likely receive just around the Fair Market Value for it. And according to the tax laws, you won’t see a capital gains tax on anything at or below Fair Market Value when your parent passed. If you sell the house at less than its “stepped-up” basis, you actually have a capital loss that can be deducted against your ordinary income per year.
Benefits in selling your inherited house quickly:
- Avoid having to deal with becoming a landlord and renting the property.
- You won’t need to make a two-year commitment in moving in.
- Don’t deal with any property taxes for the house.
- Get peace of mind and closure during a difficult time.
- Best of all, don’t worry about any capital gains tax on what you receive for the property.
Selling Direct is the Fastest Solution to Sell
If want to sell the home you inherited right away to dodge additional taxes, selling direct is the perfect way to do so. Selling the house on your own or with a real estate agent could mean that the value of the house could change in the duration that it sits on the market. To ensure you sell at FMV or right around that value, a cash buyer like us can be the solution you’re looking for. There is no waiting required, and we can close on whatever time frame you’d like. Having dealt with many probate cases, we know how trying and emotional of a time it can be on families. It is at our heart to make your life easier, and a quick sale could do just that. If you’re still unsure as to which route to take, read through our full guide in what to do if you inherited a property.