Sooner or later, you may decide to sell property you inherited from a parent or other loved one. Whether the property is an investment, an antique, land, or something else, the sale may result in a taxable gain or loss. But how that gain or loss is calculated may surprise you.

Your Basis

When you sell property you purchased, you generally figure gain or loss by comparing the amount you receive in the sale transaction with your cost basis (as adjusted for certain items, such as depreciation). Inherited property is treated differently. Instead of cost, your basis in inherited property is generally its fair market value on the date of death (or an alternate valuation date elected by the estate’s executor, generally six months after the date of death).

These basis rules can greatly simplify matters, since old cost information can be difficult, if not impossible, to track down. Perhaps even more important, the ability to substitute a “stepped up” basis for the property’s cost can save you federal income taxes. Why? Because any increase in the property’s value that occurred before the date of death won’t be subject to capital gains tax.

For example: Assume your Uncle Harold left you stock he bought in 1986 for $5,000. At the time of his death, the shares were worth $45,000, and you recently sold them for $48,000. Your basis for purposes of calculating your capital gain is stepped up to $45,000. Because of the step-up, your capital gain on the sale is just $3,000 ($48,000 sale proceeds less $45,000 basis). The $40,000 increase in the value of the shares during your Uncle Harold’s lifetime is not subject to capital gains tax.

What happens if a property’s value on the date of death is less than its original purchase price? Instead of a step-up in basis, the basis must be lowered to the date-of-death value.

Holding Period

Capital gains resulting from the disposition of inherited property automatically qualify for long-term capital gain treatment, regardless of how long you or the decedent owned the property. This presents a potential income tax advantage, since long-term capital gain is taxed at a lower rate than short-term capital gain.

Be cautious if you inherited property from someone who died in 2010 since, depending on the situation, different tax basis rules might apply.

Investing in residential rental properties raises various tax issues that can be somewhat confusing, especially if you are not a real estate professional. Some of the more important issues rental property investors will want to be aware of are discussed below.

Rental Losses

Currently, the owner of a residential rental property may depreciate the building over a 27½-year period. For example, a property acquired for $200,000 could generate a depreciation deduction of as much as $7,273 per year. Additional depreciation deductions may be available for furnishings provided with the rental property. When large depreciation deductions are added to other rental expenses, it’s not uncommon for a rental activity to generate a tax loss. The question then becomes whether that loss is deductible.

$25,000 Loss Limitation

The tax law generally treats real estate rental losses as “passive” and therefore available only for offsetting any passive income an individual taxpayer may have. However, a limited exception is available where an individual holds at least a 10% ownership interest in the property and “actively participates” in the rental activity. In this situation, up to $25,000 of passive rental losses may be used to offset nonpassive income, such as wages from a job. (The $25,000 loss allowance phases out with modified adjusted gross income between $100,000 and $150,000.) Passive activity losses that are not currently deductible are carried forward to future tax years.

What constitutes active participation? The IRS describes it as “participating in making management decisions or arranging for others to provide services (such as repairs) in a significant and bona fide sense.” Examples of such management decisions provided by the IRS include approving tenants and deciding on rental terms.

Selling the Property

A gain realized on the sale of residential rental property held for investment is generally taxed as a capital gain. If the gain is long term, it is taxed at a favorable capital gains rate. However, the IRS requires that any allowable depreciation be “recaptured” and taxed at a 25% maximum rate rather than the 15% (or 20%) long-term capital gains rate that generally applies.

Exclusion of Gain

The tax law has a generous exclusion for gain from the sale of a principal residence. Generally, taxpayers may exclude up to $250,000 ($500,000 for certain joint filers) of their gain, provided they have owned and used the property as a principal residence for two out of the five years preceding the sale.

After the exclusion was enacted, some landlords moved into their properties and established the properties as their principal residences to make use of the home sale exclusion. However, Congress subsequently changed the rules for sales completed after 2008. Under the current rules, gain will be taxable to the extent the property was not used as the taxpayer’s principal residence after 2008.

This rule can be a trap for the unwary. For example, a couple might buy a vacation home and rent the property out to help finance the purchase. Later, upon retirement, the couple may turn the vacation home into their principal residence. If the home is subsequently sold, all or part of any gain on the sale could be taxable under the above-described rule.

Obtaining a significant tax benefit for charitable contributions may be a little harder after the Tax Cuts and Jobs Act of 2017 (TCJA), but it’s not impossible. Here’s a look at how the TCJA has altered the tax landscape for charitable giving and three strategies that could help taxpayers get better tax mileage from their donations going forward.

What Has Changed?

Because the deduction for charitable contributions is an itemized deduction, taxpayers who claim the standard deduction receive no deduction for their contributions. That much hasn’t changed. What has changed is that standard deductions for every filing status are significantly higher under the TCJA. And since there are new limits on some itemized deductions — e.g., the deduction for state and local taxes — and others have been outright eliminated, taxpayers are less likely to benefit from itemizing in the first place. But if they do, cash contributions are generally deductible up to 60% of adjusted gross income (AGI), versus the pre-TCJA limit of 50% of AGI.¹

Timing Donations With a Donor-Advised Fund

With a donor-advised fund, you make a contribution (or series of contributions) to the fund and recommend how you would like your gifts to be disbursed. Generally, the donor’s recommendations will be followed, but the sponsoring organization has the final say as to how the money is actually distributed.

Contributions to a donor-advised fund are generally tax deductible in the year they are made. So funding a donor-advised fund in a year you expect to itemize your deductions could provide a tax advantage. If desired, you could then put those dollars to use over several years by supporting your favorite charities through your donor-advised fund.

Donating Appreciated Securities

Many donor-advised funds and other public charities accept contributions of publicly traded stock or other securities. A donation of highly appreciated securities held more than one year provides a potential tax deduction for the securities’ fair market value while also avoiding the capital gains tax that would be due if the securities were sold. Note that itemized deductions for contributions of appreciated securities are generally limited to 30% of AGI.1

Making QCDs After Age 70½

A qualified charitable distribution (QCD), also known as an IRA charitable rollover, allows you to donate to qualified charities directly from your individual retirement account (IRA). While there is no tax deduction allowed for the donated assets, they don’t count as income either. What’s more, a QCD can help satisfy your annual required minimum distribution (RMD).

To make a QCD you must be at least 70½ years of age. Gifts must be made directly from your traditional or Roth IRA to a public charity. (Contributions to donor-advised funds are not eligible.) Up to $100,000 may be transferred annually.

Before implementing any tax planning strategy, be sure to discuss it with your tax advisor. Each individual’s tax situation is different, and your tax advisor can help you analyze the impact on your personal situation.

Source/Disclaimer:

¹Technically, the percentage limit is applied to a taxpayer’s “contribution base.” Contribution base is AGI but without deducting any net operating loss carryback to that year.