The subject of taxes intimidates many people, but the basic concept of estate taxes when it comes to real estate is relatively straightforward. Whether you are buying a home from an estate or selling an inherited property, understanding federal and local capital gain taxes is an important consideration. 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.
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How it works
When you inherit property, the asset’s cost basis steps up to the current fair market value. With New York City’s real estate experiencing strong growth over the last decade, despite the recent softness, this is beneficial to your heirs.
As an 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 now worth $2 million, that is your new cost basis after you receive 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 capital gains.
Even better for the taxpayer, the long-term capital gains tax rate applies. These are more favorable than the tax rate on ordinary income. 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) when it goes up to 20%.
What about a gift?
You may decide you want your heirs to enjoy the property while you are still around. There are a lot of reasons for doing so. Perhaps he or she needs the money now, or you want to see the joy that your home brings to your child or another family member. Should you choose to do it this way, the recipient does not benefit from the stepped-up basis, however. Instead, his or her cost basis is the same as yours. Your awareness of the annual limit on gifts you can give is important to note; otherwise, you could be on the hook for taxes.
Ditching the exclusion
For those wondering if you can also take the $250,000 or $500,000 home sale tax exclusion, the short answer is no, generally speaking. This exemption allows single filer homeowners to exclude the lower amount from the profits that would have been subject to a capital gains tax, which doubles for married couples that file a joint return.
This is a nice windfall for homeowners, who can use the exemption every two years. However, you cannot use it when you are selling an inherited home unless you move in and live there for at least two years.
State 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. Given the local market’s strong price appreciation, this should save you money on your taxes when you decide to sell.
Inheritance 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. On the federal level, an individual’s estate is subject to taxation if the value is above $11.4 million, which climbs to $11.6 million next year.
New York’s estate tax, which has rates ranging from 3.06% to 16%, starts when assets are about $5.5 million. The state adjusts the minimum asset threshold for inflation annually. But, if the estate exceeds this amount, the tax is triggered, and New York bases the bill on the entire amount of assets.
Final 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 there has been 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.
In the event you have a capital loss, you can reduce your income by $3,000 a year until you have exhausted the amount. Alternatively, you can use the amount to offset capital gains.
