If you were gifted real property in the Last Will and Testament of someone who recently died you may be concerned about the tax ramifications of that gift. As you likely already know, Uncle Sam taxes just about everything in the United States. The good news is that as a general rule, gifts made by a decedent at the time of death do not create an immediate tax liability for the recipient of the gift. If the gift is real property, however, you could incur capital gains taxes at some point down the road when you sell the property. If you do decide to sell the property though, you may be able to use a “ step up in basis ” when calculating the capital gains tax due on the sale.
In the normal course of events, a taxpayer is required to pay taxes on the gain realized upon the sale of a “capital” asset. What is a “capital” asset? According to the Internal Revenue Service – just about anything. In practice, however, capital gains taxes are only paid upon the sale of high value capital assets such as real property. “Realized gain” is the difference between what you paid for the asset and what you sell it for at the time of sale. For example, imagine that you purchased a vacation property in Florida 15 years ago and paid $150,000 for the property at that time. Imagine further that you sell the property tomorrow for $250,000. The “realized gain” from the sale is $100,000 ($250,000 – $150,000). You would owe capital gains tax on $100,000 unless an exemption or exception applies.
When you are gifted a capital asset, such as real property, you are often allowed to use a stepped up basis when calculating capital gains taxes should you sell the asset at some point after it is gifted to you. A step up in basis means that you may use the fair market value at the time the gift was made as your starting point for the purpose of calculating capital gains taxes. By way of illustration, assume that instead of selling your vacation home you hold on to it until your death whereupon it is gifted to your son. Instead of using the $150,000 you paid for the property as the basis your son can use the fair market value at the time of the gift. If you died tomorrow and the property is now worth $250,000 your son may use that figure as his basis. Therefore, he could sell the home immediately and pay nothing in capital gains tax or he could hold onto the property with the knowledge that when he does sell the home he will pay less in capital gains tax than he would have had he been forced to use your basis in the property.
If you have additional questions about how capital gains taxes may impact gifts you make or receive in an estate plan contact an experienced Illinois estate planning attorney.
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