A Step Up in Tax Basis - A HUGE Tax Benefit
In an earlier entry, I discussed the general framework that tax professionals use to determine if a home seller will be experiencing a gain or loss. You can find that entry here: https://www.harpta.com/post/real-estate-sale-gain-or-loss . Given this information, there are 2 main ways to lower your gain, or increase your loss when you sell. And of those two ways, only 1 is generally sensible.
The 2 ways to lower gain or increase losses: lower your net selling price, or increase basis. Lowering the net selling price is usually not a wise thing to do, because it's generally better to make more money and pay tax on it, than make a choice not to make the money at all, which is what a home seller is usually doing if they lower their net selling price. So because of that, we usually focus on increasing the tax basis in the property.
For most home owners, their original tax basis is usually what they paid for the property, plus incidental charges that were directly associated with the purchase. However, not everyone acquires real property by purchasing it. Some people inherit property they own.
When someone inherits real property, according to Internal Revenue Code Section 1014, the original basis is the fair market value as of the date that the decedent passes away (or an "alternate valuation date", usually 6 months from the date of death). That means if someone inherits real property and sells it shortly after they inherit it, they will often have absolutely no capital gains tax on the sale! That automatic increase in basis upon the passing of the decedent is known as "basis step up".
If you inherit property and are thinking about possibly selling it, please visit with a qualified tax professional to find out if your property is subject to basis step up, and how your taxes will be affected by the sale.