The subject of taxes intimidates many people, but the basic concept of estate taxes for real estate is relatively straightforward. Whether buying a home from an estate or selling an inherited property, understanding federal and local capital gain taxes is essential. After all, knowing the seller’s tax treatment on the sale can affect your offer or, on the flip side, alter your financial planning when you are preparing to sell the home. If you already own an apartment, this can influence your estate planning.
While taxes and death are the two things that are unavoidable, grasping the former can improve your decision-making process.
How Estate Taxes WorkHow Estate Taxes Work
The asset’s cost basis steps up to the current fair market value when you inherit property. With New York City’s real estate experiencing steady growth over the last decade, this benefits your heirs despite the recent softness.
For example, let’s say your parents bought a Manhattan co-op 15 years ago. In 2004, the median co-op and condo price for a two-bedroom unit in the borough was $990,000. Assuming it is worth $2 million, that is your new cost basis after receiving the asset. When you sell your inherited unit, the difference between the sales price and your stepped-up cost, $2 million, is the amount you pay for capital gains.
Even better for the taxpayer, the long-term capital gains tax rate applies. This is 0% if you are in either the 10% or 12% income tax brackets. It climbs to 15% until you reach the 37% bracket (taxable income above $479,000 for married filing jointly filers) and goes up to 20%. These are more favorable than the tax rate on ordinary income.
What about a Gift?What about a Gift?
You may decide you want your heirs to enjoy the property while still around. There are a lot of reasons for doing so. Perhaps they need the money now, or you want to see the joy that your home brings to your child or another family member. However, if you choose to do it this way, the recipient does not benefit from the stepped-up basis. Instead, their cost basis is the same as yours. Your awareness of the annual limit on gifts you can give is important; otherwise, you could be on the hook for taxes.
Ditching the exclusionDitching the exclusion
For those wondering if you can also take the $250,000 or $500,000 home sale tax exclusion, generally speaking, the short answer is no. This exemption allows single filer homeowners to exclude the lower amount from the profits that would have been subject to a capital gains tax and doubles for married couples filing a joint return.
This is a nice windfall for homeowners, who can use the exemption every two years. However, you cannot use it when selling an inherited home unless you move in and live there for at least two years.
State and city taxesState and city taxes
Both New York State and New York City impose capital gain taxes. While the taxpayer pays these at the ordinary income tax rates, the asset’s value steps up to the current fair market value. The local market’s strong price appreciation should save you money on your taxes when you decide to sell.
Inheritance taxInheritance tax
You do not have to worry about paying an inheritance tax since the federal government and New York do not have one. This is an amount levied on individuals once the property comes into your possession.
Large estates may owe taxes, though. An individual’s estate is subject to taxation on the federal level if the value is above $11.4 million, which climbs to $11.6 million next year.
New York’s estate tax ranges from 3.06% to 16% and starts when assets are about $5.5 million. If the estate exceeds this amount, the tax is triggered, and New York bases the bill on the entire amount of assets. The state adjusts the minimum asset threshold for inflation annually.
Final thoughtsFinal thoughts
Taxes influence people’s decisions in logical and illogical ways. The estate tax’s generous step-up provision allows the seller to minimize taxes, assuming price appreciation. You also get to deduct certain expenses, such as real estate commissions, further lowering your tax payment. Any major work you’ve done also gets added to your cost basis.
If you have a capital loss, you can reduce your income by $3,000 annually until you have exhausted the amount. Alternatively, you can use the amount to offset capital gains.
