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Understanding the “step up in basis” rule on inherited property

On Behalf of | Feb 19, 2023 | Probate & Trust Administration

Here in Southern California, the price of real estate has skyrocketed over the years. If your parents spent $50,000 on a home back in the 1970s, they may have seen the value grow ten- or twentyfold. That’s especially true if it’s in an area that’s been gentrified or just “rediscovered” and is now one of the hot neighborhoods.

If you have a loved one who’s offering to leave you a home like this after they pass away, you may wonder how much of that value is going to be eaten up by capital gains tax if you turn around and sell the property for what it’s worth today (or in the future).

Fortunately, heirs and other beneficiaries are protected from having to pay the full capital gains tax on property they’ve inherited. The “step up in basis” rule limits the amount of capital gains tax that beneficiaries are required to pay.

An example of how the step up in basis rule works

Under this rule, say you inherit that home that your parents paid $50,000 for and was valued at $500,000 when your last surviving parent died. You keep it for a few years before you sell it, and during that time the value increases even more – to $520,000. The capital gain is just $20,000 – the difference between when your parent died and when you sold it. Maybe with the fluctuating real estate prices, the value decreased. You might be able to write off a capital loss on your taxes.

There are a lot of ways to avoid paying capital gains tax on an inherited home. That’s something you should discuss with a tax advisor. However, if you’re turning down an offer of a home that’s been in your family your whole life and then some because you fear the capital gains tax, it’s crucial to understand the step up in basis rule.

It’s always wise to seek legal guidance in addition to talking with tax and real estate professionals if you’re considering whether to accept – or have already been left – a valuable piece of real estate.