Several weeks ago, I received a phone call from a client whose elderly mother owned several pieces of real estate in an exclusive part of town. She had purchased the property decades ago for very little, but since then, the property had appreciated more than a hundredfold. She asked about the tax consequences of selling this highly appreciated property after her mother died.
As it turns out, my friend and accountant, Ranjana Batra’s recent newsletter topic was about just that. I’m delighted that she has graciously allowed me to share the following expanded version of her informative article with my readers.
Receiving a gift is not a taxable event to the one who receives the gift. The gift-giver, or donor, is responsible for paying gift taxes if the gift exceeds the annual gift tax exclusion, which is $14,000 this year.
As the recipient of the gift, you are not required to report any gifts you receive on your income tax return. This is true whether the gift you received is in cash or other property.
However, when you sell the gifted property, taxes become an issue. You are considered to have owned the property for as long as the donor owned it, and you also take the donor’s cost basis. This is true for gifts made while the donor is alive. Property received from an estate is treated differently. The beneficiary of inherited property receives a step-up in basis.
So how does this work on your tax return? Let’s assume that your mother gave you a piece of real estate three months ago, and the real estate has a current value of $100,000. Let’s further assume that your mother owned the property for twenty years and paid $30,000 for it.
If you sell the property this year for $100,000, you will have a long-term capital gain of $70,000 ($100,000 minus your mother’s cost of $30,000). Because you are deemed to have owned the property for twenty years, you get the favorable long-term capital gain treatment, which caps out at 20% this year, and varies depending on your tax bracket.
Now suppose rather than having received the same property during your mother’s lifetime, you inherit it instead after she dies. You will receive a step-up from the original cost basis from $30,000 to $100,000. If you sell the property right away, you will not owe any capital gains taxes. If you hold on to the property and sell it for $125,000 in a few years, you will owe capital gains on $25,000 (the difference between the sale value and the stepped-up basis).
In the case of highly appreciated property, the step-up in basis can significantly reduce the amount of capital gains tax that is owed when the property is sold.