Sell inherited property as soon as possible if you want to avoid a capital
gains tax. In this episode, I'm going to address the
question "How to avoid paying capital gains tax on inherited
property." And get ready because you're going to
learn some things that maybe you didn't
understand.
So, I'm Doug Andrew. I've been a financial
strategist and retirement planning specialist for
more than 46 years. And I've helped many, many thousands of
clients during 4 ½ decades pay the least amount of income tax and
also capital gains tax on highly appreciated
assets when they sell them. So, in this episode, I'm going
to share with you the current law when I'm recording this
which is fall of the year 2020. And I'm going to
put some caveats because a lot of times government revenuers... And this is an
election year when I'm recording this. This is Trump and Biden. Biden has
already announced if he becomes president, he will change the capital
gains tax rate and do away with a step up in basis because he needs
to raise about 800 billion dollars for one of his health care initiatives.
And so, the laws can change. And so, in this
episode, I'm going to talk about what the law is now.
And also, what it could change to become because of proposals that are being made
by in particular the democrat party. In order to raise tax revenue. So, under
the law as it exists in the year 2020 is similar to what it's been for many
many different periods of time. Since income tax
and federal tax was instigated clear back in 1913.
And so, currently, the beauty of having an asset that appreciates over time
and then when you sell that asset, it triggers a capital gains tax. Now,
you need to know from the outset, I've never thought the capital gains tax is
fair. But that has nothing to do I guess with
what the government decides to do. Because
you're paying tax on inflation a lot of the time.
In other words, as you buy a piece of property and if it appreciates
at 3-4 percent a year, that's basically the inflation
rate many times. And so, you're having to pay tax
on what things inflated the cost of living went up.
So, I don't think capital gains tax is really a fair tax.
But it's a time when people get a lump sum usually from selling an asset and
that's when the government, government revenuers want to come in
swoop in and take their share of whatever profit. If there's
money going across the table. The capital gains tax has
fluctuated through the years based upon who's in congress and who's in the
executive branch between being taxed at the ordinary
income tax rate. Normally just income tax rates.
Or whether it's a reduced rate. Now, as I'm recording this, the trump tax
cuts have sheltered capital gains to where if you
make less than a certain amount of income, you don't pay any capital gains
tax. But you need to be aware that the
capital gains that you realize are calculated into your income to
determine what the capital gains tax rate is. And
so, you can go from zero and then it jumps to 15% and then
it jumps to 20% if you make a certain amount of income.
Now, because of the Obama administration passing what was called Obamacare, in
order to fund that proposal and they've been adding
another 3.8% on top of the 20% for the the health care initiative
called Obamacare. Now, that's the federal rate. Now, 41 out of 50 states has an
income tax. And many of those same states will
then charge you a capital gain tax also at their state rate. Maybe 5%
or what have you. So, I have sold some property in the last
2 years. And I've actually paid because of my income 23.8%
in capital gains tax to the federal government and another 5%
to the state where I live. And so when you add all that up,
it's 28.8%. And so, this is a significant amount. But if they go back
to the ordinary income tax rate which is
what Joe Biden has proposed he wants to do, he wants to
move that back up to the 39.6%. So from
basically 20% up to 39.6%. Plus I'm sure they'll add the 3.8 on top
of that for the Obamacare. That would almost double
the capital gains tax rate. But not only that. He wants to do away with the
step-up and basis on long-term capital gains which comes back full circle
to my answer to this question --How to avoid paying capital gain tax on
inherited property? So, let me use an example of
what normally happens when someone inherits a piece of
property or stocks or what have you that have
appreciated through the years. How do they calculate the capital gains
tax on inherited property? Under the current
law, you have a step up in basis. So, let's say
years ago, your parents bought a piece of property maybe a rental duplex
or something for $250,000. And now it's worth a million.
Well, when you purchased that at $250,000, maybe 50,000 of it was the land and the
other 200,000 was the building. Most people who own rental properties
for example will depreciate it down over 27 years or
sometimes under certain tax law, you can accelerate that.
But a lot of times, there's been enough time go by
the property was depreciated down to the value of the land.
So now, that's called your basis. Your basis isn't what you originally
paid for it. If you buy stock, that's your basis. But your basis in real estate
is what you paid for it less the depreciation.
So, in this example, I just used it would be down to 50,000 as the basis, not 250,000
because you've been getting the tax write-offs. And so, what happens is people
usually they sell a property and they're going to have to pay a capital gain
tax. Unless they roll that into a new-like property, that's called
section 1031 of the internal revenue code. So, regardless of whether that
property was held for a long time or people sold it and bought another like
property again and again, that's called a 1031
exchange, the basis remains at that original
amount. So, what happens is that when you go to
sell it, you calculate that entire gain. Let's say
you sold this property for a million dollars that i just talked about
and the basis is down to 50,000. You have to pay a capital gain
tax on the 950,000 of gain. Now, the only way to avoid
it is to either keep rolling it over into new property or
when someone passes away, the children, the heirs inherit that property.
Let's say this million dollar property. They get a step up in basis. Now, they
only have to pay capital gain tax on what they will sell it
for down the road if they wait on what it uh
sells for over and above the step up to 1 million.
So, they didn't have to pay a capital gain tax. That's been the beauty behind
hanging on to properties until someone passes away.
You inherit the new property and you get a step up in basis.
Or if you gift it to a charity like a church or the red cross or the boy
scouts or whatever, they get a step up in basis. Now, what
Biden is proposing that the capital gains rate goes up to
nearly 40%, but also get rid of the step up
and basis on long-term capital gains. And that means
anybody that inherits property is going to have to pay tax when they sell it.
So, my advice may be well keep postponing. Are you really saving by postponing?
I sometimes think it's better to bite the bullet and get the taxes over and
done with. And maybe reposition that money into something that's going to
be a better investment. Many times that's the case.
But if you want to avoid a capital gain tax,
which is the question in this video and you inherit it,
under current law, if you get a step up in basis,
sell it as soon as possible. Because you won't have to pay a capital gains tax.
If you sell it, then you take that money and
you can put it into new property or a different investment and maybe get a
better rate of return. So, the key takeaway
from this is if the simple question is "How to avoid capital gain tax on
inherited property?" Under current law when i'm recording
this, I would say, "As soon as possible" because
you get the step up in basis. If they have done away with a step up in
basis at the time that you're viewing this
episode, then you could continue to postpone and
delay until you realize again. But they may even change the laws to
where when you inherit the property. You must pay a capital gain tax to
inherit it and that forces many people to then
have to sell the asset if you don't have the cash.
I'm a proponent of You know what? Take advantage and
sell it and pay whatever tax you need to pay
and then reposition that money into something that's going to be maybe a
better investment that will be tax free from that point
forward. So, I would implore you to watch other
episodes about capital gains tax on this channel, 3-Dimensional Wealth. You'll
gain insights into opportunities maybe you didn't know existed before and you
will probably learn about where I have told many of my clients
once they sell their property and they avoid the capital gain tax or
they pay the lowest amount possible, where I suggest they reposition that net
after tax money to have it compound and grow tax free
from now on. So, if you have questions, be sure and type in your
question or comment below. And I can record a YouTube that will go
deeper into an area that maybe you need clarification on. But
watch this episode to learn a little bit more about
these topics.
you