How to avoid paying Capital Gains Tax on Inherited property?

10 mins read

No matter how educated you are, there are some numbers that are vital in the real world but which are difficult to fathom. Stuff like taxes, inflation, recession, depreciation and the calculation that goes behind them is hard to comprehend for most of us. But understanding these terms properly can make a huge difference. Today, we will discuss Capital gains tax and how to avoid paying Capital Gains tax on inherited property? We will also inform you ways to calculate how much is capital gains tax on inherited property.

What is meant by Capital Gains?

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We all know what taxes are and the various types that exist. You have direct and indirect taxes just like you have tax on income, wealth, property, sale of goods, etc. But what is meant by capital gains? Capital is what you invest in your business, this investment when it increases by a significant amount, now becomes taxable just like most stuff around you. In a broad sense when you hold a non-inventory asset like property, real estate, stocks, precious metals, etc and their value appreciates then that signifies that your capital has gained value and therefore this appreciation is termed to be capital gains.

These capital gains of yours attract taxes as they grow just as is the case with income which starts from a non-taxable amount and slowly goes up and increases the rate at which you are charged when your income starts increasing. Bahrain, Barbados, Belize, Cayman Islands, Isle of Man, Jamaica, New Zealand, Sri Lanka, and Singapore are some countries that do not ask for capital gains tax but that is not the case with the United States of America.

Now that we know a bit about Capital Gains tax we will try to answer the first and most important question, how to avoid paying capital gains tax on inherited property?

How to avoid paying Capital Gains Tax on Inherited property?

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Inheritance is when you get property from someone from your family or someone to whom you might be a legal heir and they leave a will to be acted on after their death or when they are alive to transfer the property to your name. Now while this may seem to be a good opportunity or a positive situation where you stand to make a good amount of money from these sudden gains with this gift what is also coming is the many legal procedures of which one is the payment of capital gains tax if you wish to sell your new inheritance which can be a sizeable problem in itself.

Now capital gains tax is not a small problem to navigate through because there are various stipulations and numbers to take care of within it. Firstly, there are two types of capital gains tax, short-term and long-term. Short-term capital gains tax applies to assets that you sell for profit within a year of obtaining while long-term capital gains tax is applied to stuff that you sold for profit after having it for more than a year.

Tax percent/Payer Single Person Married Couples filing jointly Married Couples filing separately Head of Household
0% 0 dollars to 41,675 dollars 0 dollars to 83,350 dollars 0 dollars to 41,675 dollars 0 dollars to 55,800
15% 41,676 dollars to 4,59,750 dollars 83,351 dollars to 5,17,200 dollars 41,676 dollars to 2,58,600 dollars 55,801 dollars to 4,88,500 dollars
20% 4, 59,751 dollars or more 5,17,201 dollars or more 2,58,601 dollars or more 4,88,501 dollars or more

Above you have the long-term capital gain tax rates and amount for the year 2022 and below you have the tax rates and amounts for the year 2023 for each party when it comes to capital tax gains.

Tax percent/Payer Single Person Married Couples filing jointly Married Couples filing separately Head of Household
0% 0 dollars to 44,625 dollars 0 dollars to 89,250 dollars 0 dollars to 44,625 dollars 0 dollars to 59,750
15% 44,626 dollars to 4,92,300 dollars 89,251 dollars to 5,53,850 dollars 44,626 dollars to 2,76,900 dollars 59,751 dollars to 5,23,050 dollars
20% 4,92,300 dollars or more 5,53,850 dollars or more 2,76,900 dollars or more 5,23,050 dollars or more

And below you can look at the figures for short-term capital gains and the tax percentage chargeable on them in 2022.

Payers/Percent 10% 12% 22% 24% 32% 35% 37%
Single Up to 10,275 dollars 10,276 dollars to 41,775 dollars 41,776 dollars to 89,075 dollars 89,076 dollars to 1,70,050 dollars 1,70,051 dollars to 2,15,950 dollars 2,15,951 dollars to 5,39,900 dollars Over 5,39,900 dollars
Head of Household Up to 14,650 dollars 14,651 dollars to 55,900 dollars 55,901 dollars to 89,050 dollars 89,051 dollars to 1,70,050 dollars 1,70,051 dollars to 2,15,950 dollars 2,15,951 dollars to 5,39,900 dollars Over 5,39,900 dollars
Married Joint filing Up to 20,550 dollars 20,551 dollars to 83,550 dollars 83,551 dollars to 1,78,150 dollars 1,78,151 dollars to 3,40,100 dollars 3,40,101 dollars to 4,31,900 dollars 4,31,901 dollars to 6,47,850 dollars Over 6,47,850 dollars
Married Separate filing Up to 10,275 dollars 10,276 dollars to 41,775 dollars 41,776 dollars to 89,075 dollars 89,076 dollars to 1,70,050 dollars 1,70,051 dollars to 2,15,950 dollars 2,15,951 dollars to 3,23,925 dollars Over 3,23,925 dollars

Now to be fair these numbers look huge and taxes on them are surely going to hurt people and so there are a few ways that tell you how to avoid paying capital gains tax on inherited property which we will share with you.

Also Read: The Difference Between Financial Assets And Liabilities

Ways to avoid paying Capital Gains Tax on Inherited property

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The first way you could avoid getting tangled in this stuff is by denying the ownership of the inherited property. It is the wish of someone else to give their property to you but your wish could be to not accept it for any reason that feels fit to you and so by following the procedure of your state you can legally decline the inheritance and avoid the prospect of paying a capital gains tax down the line.

Another way to avoid the mess would be to immediately get rid of the inherited property. The value for tax is calculated based on the current value of the property when you inherited it and the price for which you sell it. If you instantly sell the inherited property the chance of making a sizable profit becomes unrealistic and with no qualifying amount of profit you find yourself safe from having to pay any taxes.

One more option to avoid paying capital gains tax would require you to adopt the inherited property as your new primary residence while selling off your old primary property. If you meet certain conditions then you can avoid paying as much as 5,00,000 dollars on that property while avoiding tax on this one. You could also sell off your property and use that money to buy a similar kind of property, which is known as the 1031 real estate exchange. If you can find a similar kind of property as the one sold in a given amount of time then you can defer having to pay capital gain taxes.

Lastly, you can seek help from financial advisors as they know loopholes and the best possible timing for various such situations and they might be able to help you with either minimizing the tax amounts or avoiding them altogether. So by following either of these mentioned methods you now know how to avoid paying capital gains tax on inherited property. However, it is better to be prepared to pay up if your wish to avoid these taxes don’t work out and that is why we will now take up a calculator and work up some numbers that you might have to cough up.

Capital Gains on Inherited property Calculator

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If we just rewind a little bit and move up then you can see the numbers shared by us in the table format which shows you what amounts attract what percentage of tax on capital gains. It is the short-term capital gains tax that tends to eat up more money than the long-term capital gains tax which is considered by many the more favorable of the two. While there are a few ways that you can avoid these taxes altogether, sometimes it may not work out in your favor and this is when you will find yourself needing a capital gain on inherited property calculator.

If you just take to the internet then you may find a lot of tax calculating websites. There are various tools to help you out with an estimation of what amount you can expect to pay in taxes on an inherited property. Capital gains taxes are not charged on the whole sum of the sale but rather only on the value gained by the asset in contention. However, you can reduce or nullify this amount and end up paying zero taxes if you just know some tricks of the trade or seek professional help as mentioned in the how to avoid paying capital gains tax on inherited property section.

How is it Calculated?

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Let’s say you inherited a property that was originally purchased for 40,000 dollars and today it is priced at 4,00,000 dollars. So for you, the base price of this property is now set at the latter price and if you sell the property immediately then you might not make a profit that fits the taxable bracket and so you avoid paying any capital gains tax on it. But if you sell this property within a year or after a year then you will be liable to pay short-term capital gain tax or long-term capital gain tax respectively.

Let’s say you sell this property for 4,50,000 dollars in the same year this means you qualify for the short-term capital gains tax which means you are subject to a tax amount between 10% and 37% on the 50,000 dollars that you gained. On the other hand, if you sell it for the same price after a year of inheriting it then you might be liable to pay anywhere between 0% and 20% of 50,000 dollars depending on the tax bracket. The taxable incomes have been mentioned above with percentages and slab-wise for you to check.

There are certain expectations when it comes to charging capital gains tax, however, there is one more method that tells us how to avoid paying capital gains tax on inherited property. Here you simply calculate the tax payable on your capital gains and set it off against expenses incurred on the sale of the property. Let’s say you sold the property for 4,50,000 dollars and of this, if the 50,000 dollars or 40,000 dollars were expenses incurred to sell the property then you are left with no profit or just 10,000 dollars in profit to be considered for tax.

How much is Capital Gains tax on Inherited property?

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The numbers in this article have so far been mind-boggling. And the only reason that capital gains tax works is because there is something known as a step-up basis that makes it possible to be able to pay these huge tax amounts. A step-up basis comes into use while inheriting a property.

Say you inherited a property that was originally worth 40,000 dollars and while you inherit it, the current worth stands at 4,00,000 dollars this means 3,60,000 dollars is the amount that qualifies for calculating the capital gain tax. However, the step-up basis ensures that 4,00,000 dollars are the new base set for future capital gain tax consideration if you sell the property in the future. We have looked at how to avoid paying capital gains tax on inherited property and you might think we have learned all that is there but there is more to learn about it.

Understanding and calculating the capital gains tax is fine but how do you know what amount is to be paid? How much is the capital gains tax on inherited property? How do you derive a number that is payable by you to the government? For this, there are set percentages in place depending on the duration for which the inherited property is held. You can pay more tax if you wish to sell the inherited property for significant property within a year of getting it or you can wait for a year and then sell it off for a decent profit while paying lesser tax.

You may have to pay anywhere between 0% and 37% on your inherited property depending on whether it was held for the long term or the short term. The qualifying amounts and percentages are mentioned in the table above. However one can’t get very comfortable with those numbers as they may change yearly and even if you ignore that you should know that Joe Biden, the United States of America President proposed changes and adjustments to the old tax laws. When the current 2022 tax laws expire the new rules may come into effect and they may paint a grim picture for the people of the US as it’s about to increase taxes and cut profits of people.

The proposed changes could see step-up basis exemption being thrown out of the picture in case the inherited property has gained more than 1 million dollars in the case of a single person or 2.5 dollars in the case of married people filing jointly. Also, the capital gains tax’s top rate might be increased further which means more profits to pay and less to keep. Now more than ever you might require to learn about how to avoid paying capital gains tax on inherited property if these changes indeed came to effect. However, it is a matter for the rich or ultra-rich to worry about, the middle-class people and poor people can sit this one out knowing it doesn’t harm them.

Also Read: Difference Between The Marginal & Weighted Average Cost Of Capital

Cost of acquisition in case of Inherited property

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Inherited property is the property that you get and not the one you opt for or might want. It is fair to be asked for taxes and charges on something that you buy as per your wish but if you are gifted something and then asked to pay for it then you might as well not accept the gift. With inherited property, you can either hold them or sell them, or even decline to get them. If you sell them instantly then you have a good chance of avoiding any capital gains tax. The cost of acquisition in case of inherited property is adjusted using the step-up basis mentioned above.

A property purchased for 10,000 dollars in say 1970s cannot be accounted for at the same value in 2022 and nor can the whole appreciated value be considered and so the current market price of the value becomes the new acquisition cost of the property. If you were to make a profit on this new price then that would qualify as a capital gain and would be subject to tax unless you use one of the methods mentioned in How to avoid paying capital gains tax on inherited property section.

You can hold the property for more than a year and then sell them to qualify for a lower percentage as a tax on capital gains. There are quite a few alternative ways to cut down the capital gain tax amount or nullify them, however, it is better to look into such matters beforehand as later on, you might have no way out but to pay up a pretty decent chunk of your profits.

So that’s all on how to avoid paying capital gains tax on inherited property. You might need capital gains on inherited property calculator well in advance if you see some inheritance coming your way so that you can calculate how much is capital gains tax on inherited property of yours and how you can save some percent of it or evade it wholly. You also know how the cost of acquisition in case of inherited property is calculated and that should relieve you a bit. Remember to seek professional help if you plan on saving a fortune worth of profit.

Sushma Singh

Sushma is a financial expert and online entrepreneur. With years of experience in personal finance and business management, she is dedicated to empowering individuals to take control of their finances and make smart investment decisions. Through Moneymint's website, she provides insightful tips, strategies and resources to help individuals grow their wealth and achieve financial stability. Join Sushma on the journey to financial freedom today!

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