“How much am I going to have to pay in taxes?” is one of the most common questions I am asked after a client experiences the death of a loved one. The tax liability of inheriting assets can be onerous and confusing. Generally, there are three types of taxes that are possible: an Estate Tax, an Income Tax, and a Capital Gains Tax on the sale of inherited property.
The New York Estate Tax: In New York, there is no inheritance tax, meaning that beneficiaries do not have to pay a tax on their receipt of assets from a decedent’s estate or trust. However, there is a New York Estate Tax, which is assessed based on the fair market value of assets held by a decedent in the State of New York as of the decedent’s date of death. For the year 2025, the New York Estate Tax exemption is $7,160,000; as such, a decedent can leave approximately $7,000,000 worth of assets to their beneficiaries without taxes having to be paid. Because the New York Estate Tax exemption is relatively high, in many cases, estate taxes are not of concern.
Income Taxes: The receipt of assets from a decedent’s estate by a beneficiary is generally not considered income to the beneficiary. For example, if you inherit real property from your mother worth $500,000, then the $500,000 value of the property is not considered income to you and is not includible as income on your annual tax return. However, if that $500,000 property is a rental property and/or is sold after your mother’s death, there may be a tax due upon the sale of the property called a Capital Gains Tax and you, as the beneficiary, will be required to pay income taxes on the net rental income generated by the property on an annual basis if you continue to own and rent said property.
Capital Gains Taxes: When real property is sold, the seller may be required to pay Capital Gains Taxes on the difference between the sales price and the property’s Cost Basis (i.e., the original purchase price of the property plus capital improvements, less depreciation). To illustrate, if your mother bought the above-mentioned property for $100,000 and made $200,000 worth of capital improvements to it (such as adding on an extension), her Cost Basis in the property would be $300,000. Thus, if she were to sell the property before her death for $500,000, then she would have a Capital Gains Tax on the $200,000 profit. (Sale Price of Property $500,000 – Cost Basis of $300,000 = Gain of $200,000). However, if your mother were to sell her primary residence she would also be able to exclude $250,000 from capital gains if a single individual and $500,000 if married.
As a future beneficiary of property, this may be concerning! Fortunately, a concept called “Stepped-Up Basis” may be able to significantly minimize or eliminate Capital Gains Taxes for a beneficiary, as long as the decedent owned the property on their date of death. Pursuant to Section 1014 of the Internal Revenue Code, the Cost Basis of property passing to a beneficiary upon the death of the owner receives a “step up” to the fair market value of the property at the decedent’s date of death. Using the same example, if your mother’s property was still worth $500,000 on her date of death, and you sell it six months later for $510,000, the taxable gain would be $10,000 (as opposed to a taxable gain of $210,000 if your mother’s original cost basis of $300,000 was used).
Stepped-up basis is one of the most beneficial tax provisions related to inherited property that currently exists and can effectively eliminate (or significantly decrease) the Capital Gains Tax liability that could arise from appreciation during the decedent’s lifetime. This offers a significant tax advantage to heirs who plan to sell the property.
So, what does this all mean from a planning perspective? While it may seem like a good idea to make an outright transfer of property during your life, thereby eliminating the need for a probate proceeding or trust administration, doing so may be detrimental when considering Cost Basis and future Capital Gains Tax!
As such, it is important that an experienced attorney (and often, an accountant) be consulted to review your exact situation and make recommendations that are beneficial from an Estate Tax, Income Tax, and Capital Gains Tax perspective. Effective planning can be done to simultaneously avoid probate, streamline distribution of assets to beneficiaries, and reap the benefits of stepped-up basis.
