The first part of understanding the tax responsibility when you plan on giving it to your family vacation home to adult children who live out of state, is to understand the definition of “basis” and “step-up in basis.” These terms refer to income taxes and are used to determine any gains or losses on the sale of the property.
When you die, property that you own or control is valued as of the date of death. The children who inherit the property take it with that value as their basis. The first thing is to determine the parent’s basis in the property. You should then look at how the basis of inherited property is handled. Generally, the basis of property inherited from a decedent is one of the following:
- The fair market value (FMV) of the property on the date of the decedent's death.
- The FMV of the property on the alternate valuation date, if the executor of the estate chooses to use the alternate valuation.
They refer to the Instructions for Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The IRS suggests that for information on the FMV of inherited property on the date of the decedent’s death, you should contact the executor of the decedent’s estate. The agency also notes that in 2015 Congress passed a new law that, under certain circumstances, requires an executor to provide a statement identifying the FMV of certain inherited property to the individual receiving that property.
When a person passes away, the property he or she owns or controls, like what’s included in their taxable estate, will be valued as of the date of death. Children who inherit the property will take the property or asset with the date of death value as his or her basis.
The step-up in basis doesn’t depend on whether or not you pay state or federal estate or inheritance tax on the property. However, if you file a federal estate tax return, the value of the property reported on the return must be the same as the value reported by the children for the property as their basis in reportable transactions.
If a person only owns part of the real property at his or her death, it’s possible only that portion will get a step-up in basis.
Because the children in this example live out of state, the current owner and heirs need to understand that some states have what is called an “exit tax.” In New Jersey, when homeowners sell their residences to move out of state, they have the pleasure of paying a standard tax rate on the profits from the sale. This tax gets paid when people move, and not during tax season.
An estate planning attorney will be able to work through the fine points with you and your children to minimize any surprises.
Reference: nj.com (July 24, 2018) “Cost Basis for and Inherited Vacation Home”