How to Reduce or Avoid Capital Gains Tax on Inherited Property

United States, 3rd Mar 2025 - Inheriting property can be both a valuable asset and a potential tax burden. One of the primary financial concerns heirs face is capital gains tax, which applies when inherited property is sold for a profit. However, with strategic planning, you can significantly reduce or even eliminate this tax liability.

At ALTA Estate, we specialize in estate planning and tax strategies, ensuring you keep more of your inheritance while complying with tax laws. Here are some effective ways to minimize or avoid capital gains tax on inherited property.

1. Leverage the Step-Up in Basis Rule

One of the most powerful tax-saving benefits when inheriting property is the step-up in basis rule. This rule allows the property’s value to be “reset” to its fair market value at the time of the original owner’s death.

• How It Works: Instead of inheriting the property at its original purchase price (which may have been much lower), the step-up in basis adjusts the value to the date of the decedent’s passing.
• Tax Benefit: If you sell the property shortly after inheriting it, your taxable gain may be minimal or nonexistent, as the sale price will likely be close to the adjusted basis.

This rule provides significant tax relief for heirs, making it a key consideration when handling inherited assets.

2. Qualify for the Primary Residence Exemption

If you move into the inherited property and use it as your primary residence, you may be eligible for the capital gains tax exclusion when selling it later.

• Exemption Amount: You can exclude up to $250,000 of capital gains if you are single, or $500,000 if married, when selling your primary home.
• Residency Requirement: You must live in the home for at least two of the five years before selling to qualify.

This strategy is ideal for heirs who plan to keep the property for a few years before selling.

3. Hold the Property as a Long-Term Investment

Instead of selling the inherited property immediately, you can hold onto it as a long-term investment.

• Lower Tax Rate: Selling after more than one year qualifies you for the long-term capital gains tax rate, which is lower than short-term rates.
• Market Appreciation: Over time, property values may increase, allowing you to sell at a higher price while benefiting from favorable tax treatment.

By delaying the sale, you gain flexibility in timing the transaction for maximum financial advantage.

4. Utilize a Trust for Tax Efficiency

Placing the inherited property in a trust can provide tax advantages and help minimize capital gains tax.

• Revocable Trusts allow flexibility, but assets remain part of your taxable estate.
• Irrevocable Trusts remove the property from your estate, potentially reducing estate and capital gains taxes.

Trusts also offer benefits like asset protection and ensuring a smooth transfer to future beneficiaries.

5. Take Advantage of a 1031 Exchange

A 1031 exchange allows you to defer capital gains tax by reinvesting the proceeds from the sale of the inherited property into another investment property.

• IRS Requirements: The new property must be of like kind, and you must identify a replacement property within 45 days and complete the purchase within 180 days of selling.
• Tax Deferral: By rolling the proceeds into another investment property, you avoid immediate taxation and continue building wealth.

This is a powerful tool for heirs who want to stay in the real estate market without incurring immediate tax liability.

6. Defer the Sale Until a Lower Tax Bracket

If you expect your income to decrease in the future, consider delaying the sale of the inherited property.

• Lower Income = Lower Tax Rate: Capital gains tax rates are tied to your income bracket, meaning you may pay less tax by selling the property after retirement or during a lower-income year.
• Strategic Planning: Timing the sale based on tax brackets can optimize your financial outcome.

This approach requires long-term financial planning but can lead to substantial tax savings.

7. Gift the Property Strategically

Gifting inherited property to family members can be an effective way to reduce estate and capital gains taxes.

• Annual Gift Tax Exclusion: In 2024, you can gift up to $17,000 per recipient without triggering gift taxes.
• Lifetime Gift Tax Exemption: Larger gifts can count toward the lifetime exclusion amount, reducing future estate tax burdens.

Careful planning is required to ensure compliance with IRS rules and avoid unintended tax consequences.

8. Consider an Installment Sale

An installment sale allows you to spread out the tax liability by selling the inherited property in phases rather than as a lump sum.

• How It Works: Instead of receiving all the sale proceeds upfront, you accept payments over time.
• Tax Benefit: By spreading capital gains over multiple years, you may remain in a lower tax bracket, reducing the total tax owed.

This strategy is particularly useful when selling to a trusted buyer and looking for a steady income stream.

Plan Ahead with ALTA Estate

Reducing or avoiding capital gains tax on inherited property requires careful planning and knowledge of tax strategies. Whether through the step-up in basis, primary residence exemption, trusts, or 1031 exchanges, there are numerous ways to minimize your tax burden.

At ALTA Estate, led by Mark Fishbein, we provide expert guidance to help clients navigate estate planning and tax-saving strategies. Contact us today to create a customized plan that preserves your inheritance and safeguards your financial future.

The text above is for general informational purposes and should not be considered legal advice. For more information, click Contact Us. Follow Mark Fishbein Tucson on LinkedIn or Facebook. Estate Planners Tucson and Living Trusts Preparers

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