Rights & Money

When You Do and Don’t Pay Tax on Inherited Property

My wife and I are joint owners of our home. Until recently, we were under the impression that after one of us died, the survivor would have to sell the house before his or her death so that the beneficiaries—our children—wouldn’t have to pay capital gains tax on the house. However, your answer to a recent question about capital gains tax on a jointly owned principal residence suggested otherwise, and it would be a great comfort to know that this isn’t necessary. So our question is, when the final joint owner has passed away, do the beneficiaries of the estate have to pay any capital gains tax?

By Olev Edur

There’s no capital gains tax on a principal residence when both joint owners have passed away and the property goes from the estate into the hands of heirs—in your case, the children. They would receive the property tax-free.

Once it’s in their hands, however, the tax clock may start ticking, unless they choose to sell it right away. If they sell right away and the sale takes place within a year of their receiving the property, there should be no capital gains tax liability. And if the children don’t own their own homes, then even if they were to decide to hold onto the property for longer than one year, they’d be able to use their own principal residence exemptions to shelter any capital gains from tax after the property is in their hands.

If, however, they do own their own homes, they’re going to face a tax liability when they sell either their own homes or the inherited property. This is because you’re allowed to own only one principal residence at any time. They would have to decide whether to designate heir homes or this property as their prin- cipal residence. As long as the inherited property is used as a residence at any point during the year, it would qualify.

The designation of a principal residence doesn’t need to be done until there’s a sale, so there may be plenty of time for the kids to decide which property to designate. Their decision will depend on whichever property accrues the most gains while they own it.