President Biden proposes the elimination of a step-up in basis in inheritance property. Anyone who’s dealt with inheritance property knows how crucial the step-up of basis is. The step-up basis is essential if you’ve completed tax forms to sell your inherited property. For tax purposes, it’s called “fair market value.” We’ll look at tax forms required for the sale of inheritance property and provide some illustrations of what a change in basis is.
Schedule D And Form 8949
The gains or losses of the inherited property are recorded during the year you sell it. A sale for the house is reported to Schedule D and Form 8949 (Sales and other disposition of capital assets).
Schedule D is where every capital loss or gain arising from the sale is declared. Profit or loss are calculated based on the step-up basis, if appropriate. Form 8949 is the form where the disposal of the property will be disclosed. It includes information such as the date of acquisition, the date the property was sold, and a description of the property. The loss or gain on the property is also recorded on Form 8949, and then it is transferred on Schedule D.
The step-up basis is calculated from the inheritance by filing Form 8971 and Schedule A. The executor of the estate generally completes the form.
A Step-Up Example In The Basis
The basis increase is the valuation of the home at the date of inheritance that occurs with the death of the property’s owner. This means that the property becomes inherited after an owner’s death.
For example, a house was bought for $250,000 20 years ago. Today, it’s valued at $1 million. The homeowner dies, and his heirs take over the house. The heirs will inherit the home at $1 million, the actual market value. The heirs’ cost basis has increased by $250,000, to $1,000,000.
If the heirs of the deceased were selling the home for the fair market price (i.e., $1 million), they would not have to pay any capital gains tax. Transfer taxes will still be due on the day of sale. If they were to sell the home for $1.1 million, the taxes would be due on the $100,000 capital gain.
This kind of inheritance is referred to as linear. It defines the heir(s) connection to the owner. Lineal descendants are the spouse, grandparents, parents, great-grandparents, grandchildren, stepchildren, and great-grandchildren. Non-lineal descendants include nephews and nieces. Non-lineal descendants are liable for inheritance taxes.
Inheriting Vs. Gifting
Transferring property to an inheritance and the gift of properties are different. If parents gift an apartment for their child, he would assume the cost basis at the time of gifting. Let’s take the same example in the above example. The son will take on the cost basis of $250,000 and will not be able to afford the $1.5 million. If the home is sold for 1 million dollars, the son would be taxed on $750,000.
In this situation, the parents might transfer the house to an irrevocable trust and take advantage of the increase in base. However, the trust language, as well as the other restrictions, have to be applied with care. Investors looking to invest in trusts must consult an attorney who is a trust.
Another option to reduce taxes on gift properties is the exchange of 1031. Instead of selling the house in full, the heir could opt to complete a 1031 swap that will delay taxes on the gains.
States And Inheritance Tax
Despite the best efforts of some investors to reduce taxes, some states impose taxes on inheritances based upon the asset’s worth. The affected conditions comprise Kentucky, Iowa, Nebraska, New Jersey, and Pennsylvania.
The process of reporting the sale of inherited property isn’t too tricky. It’s only the filing of two papers (Schedule D and Form 8949) generally. Of course, investors would need to consult with their accountant to ensure everything is completed correctly to suit their particular situation.