Many families consider leaving land to their children or grandchildren to “keep it in the family”. This can create some income tax complications when some or all of the family want to sell the property. A recent article titled “I inherited land that recently sold. What will I owe in taxes?” from The Washington Post, describes some of the complex tax issues that should be considered.
Let’s take a situation where three generations are involved. A widower owns land in east Texas. At his death, his last will states that his two sons and a daughter will inherit equal portions of the property. However, his daughter pre-deceased him, causing her share to be inherited by her son, his grandson. If the heirs decide to sell the property, what value of the land is used to determine the tax liability?
To keep this example simple, let’s assume the estate was well under the federal estate tax limits of his time and there were no federal estate taxes due.
When a person inherits an asset, they usually inherit both the asset and the step-up in the value of the asset at the time of the person’s death. If the grandfather bought the land for $30,000 and when he died the land was worth $300,000, the heirs inherit it at that “stepped-up” value.
Assuming the land was worth $300,000 at the time of his death, the grandson’s share of the land would be worth $100,000. That’s his cost or basis in the land. If he sold the land up to a year after inheriting it, receiving his share of $100,000, he would not have any federal income tax or capital gains to pay. However, after one year, any profit is taxed at the capital gains rate.
So, if after a year, the family sold the land for $390,000, the grandson’s basis in the land is still $100,000 and his sales proceeds would be $130,000, or a $30,000 profit. He would be responsible for paying income taxes on the $30,000.
If the property was not the grandson’s primary residence he would also pay a 3.8 percent tax on the sale of investment property. If the son used the home on the land as a primary residence, there would not be an investment property sales tax.
In this kind of situation where there are multiple heirs, it’s best to consult with an experienced estate planning attorney to ensure that the transaction, income taxes, and estate taxes are handled correctly.
Reference: The Washington Post (July 26, 2021) “I inherited land that recently sold. What will I owe in taxes?”