Inheritance and Capital Gains Tax?

What happens with taxes on land that you might inherit?

QUESTION: A listener asks Dave to clarify capital gains tax.  His father has a farm to sell, but may wait to give it to his children as an inheritance.  Is there a benefit one way or the other?

ANSWER: If the farm is not a personal residence, then anything he sells it for – over and above what he paid for it – will have a capital gains tax.  Capital gains tax will run him 15% on that type of sale.  For example, if he purchased the farm for $100,000 and it is now worth $500,000, he will have to pay capital gains on $400,000.

If he allows his children to inherit the property after his death and they decide to sell it, they will pay no capital gains tax.  Even though he bought the farm for $100,000 and it’s now worth $500,000, you’re inheriting at its current value of $500,000 and can avoid the capital gains tax if you choose to sell it.  That’s called a stepped-up basis.  His old $100,000 basis goes away and steps up to current market value.

If his estate is worth more than $1,000,000, then he will need professional estate tax planning and you will have to be concerned with estate tax depending on the size of the farm. 

It’s always better to inherit something, but you need to get a good estate tax planner to figure out exactly what to do with your specific situation.