INHERITED LAND AND TAXES

I recently received a question from a visitor to my law office regarding taxes on inherited land.  It was a question I have discussed with clients before so I thought I'd publish something on the subject. Here we go.

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Clients are often concerned about burdening their children with inheritance  taxes.  As to land however, that fear is largely unfounded.  

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When a person buys property, the amount they pay is their "cost basis" in the property.  Later when they sell it, that cost basis is used to calculate taxes called capital gains taxes.  If the land was owned for a year or less, the taxes paid are short term capital gains taxes.  If the property were to be held for a year or longer and then sold, long term capital gains taxes would be owed. 

The government encourages long term investments so o long term capital gains taxes are usually significantly less than short term capital gains. The exact amount of tax will vary depending on income and filing status. 

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So if you try to protect your children by selling your land before you die, you may be making a terrible mistake.  First you would incur your own capital gains tax bill.  Second, you would not be helping your kids out at all.  In fact, you would be reducing the size of your estate by the taxes you would owe.  

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Here is the good news!!!!  Your children inherit your land at the fair market value of the land at the time of your passing.  OK, what does that mean.

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When your children inherit real estate, they recieve a step-up in basis.  How does this work.  If you paid 100 dollars for land and sold it when it was 1000 dollars, you would owe capital gains taxes on 900 dollars.  

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However, if you leave your property to your children, they inherit at at value of the 1000 dollars.  Therefore, if they sell it while still valued at 1000 dollars, they would owe NO CAPITAL GAINS TAXES.  If they hold on to it then sell it for 2000 dollars, they will have to pay capital gains on the 1000 dollars of increased value.   Those long or  short term capital gains taxes would then be paid based on how long your children held the land. 

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Wow, that is huge.  It really is huge because if you hold on to property until you pass away, the government NEVER gets to tax you for the increased value of your real estate.  

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That is a great deal for you and even better for your kids.  Your kids will not be burdened with your capital gains taxes on real estate and perhaps the only tax bill they will ever receive for the property is the regular property taxes based on the stepped up value and taxes on any value increase from the time they inherited it to the time they sell it.   Therefore, if they sell it pretty soon after inheriting it, they will likely have a very small tax bill as a result which can be paid out of the sales proceeds.  That way, you, as a parent, are not burdening your children but leaving them a legacy that they can use to improve their lives.