Do You Pay Capital Gains Tax When You Sell an Inherited House in New Jersey?

When you sell an inherited house in New Jersey, capital gains tax usually applies only to the increase in value after the date of death, not to everything the house gained while the person who died owned it. IRS Publication 551 says the basis of inherited property is generally its fair market value on the date of death, so a house sold for about what it was worth then may show little or no gain.

I'm Dennis Mark Interdonato with The Dennis Mark Group. I'm not a tax professional, and your accountant makes every call on this page. But I sell estate homes across Monmouth and Ocean County, and families make better decisions about timing and price when they understand the basics before the first meeting with their accountant.

What is "stepped-up basis" on an inherited house?

Basis is the starting number the IRS uses to figure your gain. For a house you buy, it's mostly what you paid. For a house you inherit, IRS Publication 551 says the basis is generally one of these:

• the fair market value on the date of death, which is the usual case, or
• the fair market value on the alternate valuation date, if the personal representative chooses alternate valuation on a federal estate tax return.

Publication 551 adds that if you didn't receive a Schedule A (Form 8971) reporting the estate tax value, your basis can be figured using the appraised value at the date of death for state inheritance tax purposes. That's the "step up": the decades of appreciation before the death generally aren't taxed as gain to the heir.

A made-up example, for illustration only: a house worth $500,000 on the date of death that sells a year later for $520,000 is measured against the $500,000, not against what it cost in 1985. Your tax professional figures the real gain, including selling costs and anything the estate spent on improvements.

Is the gain short-term or long-term?

Long-term. IRS Publication 544 says that if you inherit property, you're considered to have held it longer than one year, no matter how long you actually held it. Sell it the month after the estate closes and it's still long-term.

Does it matter whether the estate sells it or the heirs do?

It can. IRS Publication 559, written for executors and administrators, covers the sale of a decedent's residence. When the estate owns the house and the personal representative sells it during administration, the treatment depends on how the estate holds it. If the plan is to realize the value through a sale, the IRS treats it as a capital asset held for investment, and the gain or loss is a capital gain or loss, which may be deductible. If instead a beneficiary lives there rent free and the house is later sold without first being converted to investment use, any gain is a capital gain, but a loss isn't deductible.

That's a conversation to have with the estate's accountant before anyone moves in.

What if you owned the house jointly with the person who died?

Then only part of the basis changes. IRS Publication 523 explains that a surviving spouse who owned the home jointly gets a new basis for the interest the late spouse owned, its fair market value on the date of death, while the survivor's own interest keeps its old basis. Spouses who owned it as tenants by the entirety or joint tenants with right of survivorship are each treated as having owned half. Publication 551 has a similar example for joint tenants who aren't married.

Can an heir use the $250,000 home-sale exclusion?

Usually not, unless the heir lived there. The NJ Division of Taxation says a seller can exclude up to $250,000 of gain, or $500,000 filing jointly, if they owned and lived in the home for 2 of the 5 years before the sale, and that the gain is calculated the same way as for federal purposes. An heir who never lived in the house generally doesn't meet that test, which is one more reason the date-of-death value matters so much.

A surviving spouse has a special rule. Publication 523 says a surviving spouse who hasn't remarried at the time of the sale can count the time the late spouse owned and lived in the home.

How does New Jersey tax the sale?

New Jersey's Gross Income Tax follows the same gain calculation as federal law for a residence, and residents report the gain on their New Jersey return. The closing also needs a GIT/REP form. According to the Division's guide, Buying or Selling a Home in New Jersey:

• Estates and trusts complete one GIT/REP form, which can carry multiple signatures for executors or trustees.
• New Jersey resident sellers, including estates and trusts, file GIT/REP-3 at closing and pay any tax when they file their return.
• Nonresident sellers, including estates and trusts, file GIT/REP-1 or GIT/REP-2 and pay an estimated tax at closing of 2% of the sale price or 8.97% of the net gain, unless an exemption on GIT/REP-3 applies. Any overpayment is refunded after they file.

New Jersey inheritance tax is a separate tax with its own rules, based on who inherits. See the NJ inheritance tax waiver article for how it affects the sale.

What are the common tax mistakes with an inherited house?

• Not documenting the date-of-death value. If nobody pins down what the house was worth on that date, the most important number in the calculation is a guess. Read how the date-of-death value is set.
• Using the old purchase price. The 1985 price usually isn't the starting point for an heir.
• Mixing up the two taxes. Inheritance tax is about who inherits. Capital gains is about what the house sold for.
• Moving a relative in without asking the accountant. Publication 559 shows how that can change whether a loss is deductible.
• Surprising an out-of-state estate at closing. Nonresident sellers may owe an estimated payment on the closing statement.

Frequently Asked Questions

Do I pay capital gains if I sell an inherited house right away?

Often there's little or no gain, because the basis is generally the fair market value on the date of death. If the house sells for about that amount, there may be little to tax. Your tax professional confirms it.

Do I need an appraisal of the date-of-death value?

Publication 551 points to the appraised value used for state inheritance tax purposes when no Schedule A was received. Your accountant decides whether a formal appraisal is needed. I can share my market evaluation of the home with them.

Is New Jersey inheritance tax the same as capital gains tax?

No. Inheritance tax depends mainly on each beneficiary's relationship to the person who died. Capital gains tax is income tax on the gain from the sale.

What if the house sells for less than it was worth at death?

Whether a loss counts depends on how the house was held. Publication 559 explains that a loss on a house held for investment may be deductible, while a loss on a house a beneficiary lived in rent free isn't.

This is general information, not legal, tax or lending advice. Talk with a tax professional about your situation before you sell.

About the author

Dennis Mark Interdonato is a REALTOR® and Master CDRE® who leads The Dennis Mark Group at Keller Williams Realty Ocean Living in Point Pleasant, NJ, helping buyers and sellers throughout New Jersey make their next move, with Monmouth and Ocean County as home base. See how I handle estate and probate home sales.

Keep reading

• The free Estate & Probate Guide
• Find out what the house is worth
• When I sell my home, do I pay tax? A New Jersey guide
• How to sell an inherited house in New Jersey
• Have a question this didn't answer? Send it to Dennis Mark.