Determining the Tax Basis of an Inherited Home

When it comes to the tax implications of inheriting a home, one of the key terms you need to understand is the tax basis. This is essentially the amount used as a reference when you eventually sell the home, which impacts the capital gains tax you will owe. This article will guide you through how to determine the tax basis of an inherited home and what steps to take along the way.

Understanding the Concept of Cost Basis

The tax basis is a financial term that refers to the original cost of an asset, plus any improvements made to the asset. In the context of inheriting a home, the cost basis is particularly important. It's the price you use to calculate your capital gains, which will be taxed when you eventually sell the property.

Appraising the Home Before Inheritance

Before the inheritor receives the property and even before the estate is settled, it is often necessary to get an appraisal. An appraisal provides an accurate assessment of the home's fair market value (FMV), which is essentially the price the property could be sold for on the open market. This FMV is typically used as the initial cost basis for the inheritor.

Using the FMV as the Cost Basis

During the estate settlement process, the appraised value or FMV of the home is typically recorded. This recorded FMV is the cost basis for the inheritor at the time of inheritance. This becomes the starting point for calculating any capital gains that will be incurred when the home is eventually sold.

Updating the Cost Basis with Improvements

Once the home is in the hands of the inheritor, any improvements made to the property (such as additions, renovations, or landscaping) should also be included in the cost basis. This process involves adding the cost of these improvements to the appraised value. When the inheritor eventually sells the property, the total of the original FMV plus the value of the improvements becomes the new cost basis.

Importance of Proper Documentation

The process of determining and updating the cost basis of an inherited home requires careful documentation. All appraisals and records of improvements should be stored and made readily available if they are needed for tax purposes.

Conclusion

Understanding the tax basis of an inherited home is crucial for managing your financial responsibilities. By following the steps outlined in this guide and using the correct FMV and any improvements as part of the cost basis, you can navigate the complexities of inheriting and eventually selling a home with minimal tax burden.