If you think you might be inheriting property in the future, you need to consider the tax implications. The tax implications could be very different depending on whether you choose to receive it as a gift or inheritance. You should consider the inheritance taxes and gift taxes before transferring property.
Inheriting property
In most cases, receiving property via inheritance is the most financially beneficial. When you become the owner, you take on the property at its current fair market value without paying inheritance tax on the value it has accrued since the original owner’s purchase, and the basis of the asset is stepped up to this value. It’s a great benefit since most property increases in value over time.
For example, if Uncle Harry bought a piece of property in 1935 for $5,000 and it’s worth $5 million at his death, the basis is stepped up to $5 million in the hands of his heirs, and all of that gain escapes income taxes forever. If the heir then sells this property, the capital gain is the proceeds minus the $5 million basis in the property.
Gifting Property
When a property is gifted the basis of the asset is not stepped up to its fair market value. No tax is paid at the time of the gift, but if the asset is later sold, the basis of the property is potentially much lower, resulting in increased capital gains.
In the above example, if Uncle Harry decided to make a gift of the property in honor of his 100th birthday instead of dying owning it, the basis of the property in the hands of the heirs would still be the original $5,000. Therefore if the receiver of the property later sold it, the taxable capital gain would be $4,950,000 greater than if the property had been inherited.
Gifting is still a viable option in emotional situations or when a property needs to be exchanged very quickly. There are often many other factors to consider than just the basis of the property in the hands of the recipient. Consult with a professional about the right choice for you.
This article is based on research from the following IRS codes: Sec. 1014(a)(b), Sec. 301(c), Sec. 2031(a), and Sec. 2032(c).
By: Puneetpal Kaur
Tax Manager
