What Taxes are Due When Children Inherit Home?
There are Inheritance and estate taxes as well as income taxes to consider. First, I will discuss inheritance and estate taxes.
Inheritance and Estate Taxes
State Inheritance Taxes.
One issue to address is whether the will addresses how inheritance and estate taxes will be paid, says nj.com recent article entitled “My adult kids inherited a home. What taxes are due?” The mortgage may say the estate itself will pay it before anything is paid out to beneficiaries, or it may not mention anything.
Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania are the only states that impose an inheritance tax, which is a tax on what you receive as the beneficiary of an estate.
Maryland is the one state that has both an inheritance tax and an estate tax. Its inheritance tax is up to 10%. As to the others, Nebraska’s inheritance tax can be as high as 18%. Kentucky and New Jersey both taxes inheritances at up to 16%. Iowa’s inheritance tax is up to 15%, as is Pennsylvania’s.
Louisiana no longer imposes an inheritance tax or an estate transfer tax.
Keep in mind, that even if you are not a resident of one of these states upon your death, if you own any real estate situated in one of these states, that real estate will be subject to that state’s inheritance tax or estate transfer tax.
Spouses and certain other heirs are usually excluded by the state from paying inheritance taxes.
A child may have an issue if there’s not enough liquidity in the estate, separate from the house to pay the taxes. If the beneficiaries plan to keep the home, they’d need to take an additional mortgage. They’d also need to find enough cash to pay the inheritance taxes due.
In the example above, if the deed is transferred to a niece and nephew, the executor should hire a licensed real estate appraiser and pay for a date of death appraisal on the property. That appraisal will determine how much capital gains was exempted at the sister’s passing. It will also establish a new basis for capital gains purposes for the niece and nephew.
If the heirs simply do nothing and move into the house, the inheritance tax will come due. In New Jersey, it’s due eight months from the date of death.
If the inheritance tax isn’t paid, liability for the unpaid tax will attach to the executor personally, often in the form of a certificate of debt attached to some asset belonging to the executor, like his or her house.
Federal Estate Taxes
Federal estate taxes due by your children when they inherit your home are potentially payable on the value of a home if the value of the entire estate is more than $11.7 million (under current law in 2021). The Biden tax proposal seeks to reduce the $11.7 million exemption to $5 million. Most people do not fall into this category. But keep in mind, that if you are in your 50s and you have $2.5 million in assets, your assets can easily grow to $5 million upon your death in a couple of decades using the “Rule of 7”. The Rule of 7 states that wealth generally doubles every 7 years. So estate tax planning should usually be considered by clients who have several million in assets even when they are relatively young.
Federal and State Income Taxes
Under the recent tax proposal submitted by President Biden to congress, there would be an elimination in the “step up” in basis at death. If this provision were enacted, then heirs would have to pay income tax on an the inheritance of a home when it is sold. Unfortunately, I call this a “hidden estate tax” administered through the income tax system, and it is extremely regressive.
How does the “step up” work? If you have home (or most any property, including stocks), purchased for $50,000 many years ago, and it is worth $200,000 upon your death, your heirs “tax basis” in the property is “stepped up” from $50,000 to $200,000, thereby eliminating any capital gains tax that they would pay on the property. In this case, the capital gains would be $150,000, (assuming your heirs can prove the original $50,000 basis). This capital gains would be taxable at the applicable capital gains tax rate for each of the heirs. Not coincidentally, the Biden plan seeks to increase capital gains tax rate to, in general, equal income tax rates. That would be a rate of some 35-40%.
To make matters worse, Louisiana does not have a capital gains preference, and because Louisiana “piggy backs” the federal income tax system, Louisiana would impose its own income tax on the inheritance of your home by your children to the tune of up to 6%.
Accordingly, it would not be uncommon for most clients to pay anywhere between 35% and 45% on an inheritance. This is why I personally oppose the Biden plan. It is extremely regressive, and targets middle class families from accumulating wealth.
Reference: nj.com (June 14, 2021) “My adult kids inherited a home. What taxes are due?”