Is the money received from the sale of inherited property considered taxable income?

To determine if the sale of inherited property is taxable, you must first determine your basis in the property. The basis of inherited property is generally one of the following:

(1) The fair market value (FMV) of the property on the date of the decedent's death.

(2) The FMV of the property on the alternate valuation date if the executor of the estate chooses to use alternate valuation. See Form 706 (PDF), United States Estate (and Generation-Skipping Transfer) Tax Return.

(3) The special use valuation for estate tax purposes of qualified real property used for farming purposes or in a trade or business other than farming. However, if an interest in such property is disposed of or ceases to be used in a qualified use during the 10 year period following the decedent's death, additional estate tax is imposed. If the qualified heir elects to pay interest on the additional estate tax, the adjusted basis of the property will be deemed to have been increased, immediately before disposition, by an amount equal to the excess of its fair market value on the date of the decedent's death over its special use value. See Form 706 (PDF), U.S. Estate (and Generation-Skipping Transfer) Tax Return and section 2032A of Internal Revenue Code.

(4) If an election is made to exclude a portion of the value of land from a decedent's gross estate section 2031 (c) (regarding the transfer of qualified conservation easement), the decedent's adjusted basis in the land to the extent the value of the land was excluded from the decedent's gross estate under 2031(c) by reason of the transfer of a qualified conservation easement plus the fair market value of the land to the extent the value of the land was included in the gross estate. For more information on qualified conservation easement see the Instructions for Form 706, U. S. Estate (and Generation-Skipping Transfer) Tax Return and section 2031(c) of the Internal Revenue Code.

If you or your spouse gave the property to the descendent within one year of their death, see Publication 551, Basis of Assets.

Report the sale on Form 1040, Schedule D (PDF), Capital Gain and Losses. If you sell the property for more than your basis, you have a taxable gain. For information on how to report the sale on Schedule D, please see Publication 550, Investment Income and Expenses.

I sold my principal residence this year. What form do I need to file?

If you meet the ownership and use tests, you will generally only need to report the sale of your home if your gain is more than $250,000 ($500,000 if married filing a joint return). This means that during the 5-year period ending on the date of the sale, you must have:

Owned the home for at least 2 years (the ownership test), and

Lived in the home as your main home for at least 2 years (the use test).

If you owned and lived in the property as your main home for less than 2 years, you may still be able to claim an exclusion in some cases. The maximum amount you can exclude will be reduced. If you are required or choose to report a gain, it is reported on Form 1040, Schedule D (PDF), Capital Gains and Losses .

If you were on qualified extended duty in the U.S. Armed Services or the Foreign Service you may suspend the five-year test period for up to 10 years. You are on qualified extended duty when:

At a duty station that is at least 50 miles from the residence sold, or

When residing under orders in government housing, for more than 90 days or for an indefinite period.

This change applies to home sales after May 6, 1997. You may use this provision for only one property at a time and one sale every two years.

For additional information on selling your home, refer to Publication 523, Selling Your Home .

If I sell my home and use the money I receive to pay off the mortgage, do I have to pay taxes on that money?

It is not the money you receive for the sale of your home, but the amount of gain on the sale over your cost, or basis, that determines whether you will have to include any proceeds as taxable income on your return. You may be able to exclude any gain from income up to a limit of $250,000 ($500,000 on a joint return in most cases). If you can exclude all of the gain, you do not need to report the sale on your tax return.

For additional information on selling your home, refer to Publication 523, Selling Your Home.

If I take the exclusion of capital gain tax on the sale of my old home this year, can I also take the exclusion again if I sell my new home in the future?

With the exception of the 2-year waiting period, there is no limit on the number of times you can exclude the gain on the sale of your principle residence so long as you meet the ownership and use tests.

I lived in a home as my principal residence for the first 2 of the last 5 years. For the last 3 years, the home was a rental property before selling it. Can I still avoid the capital gains tax and, if so, how should I deal with the depreciation I took while it was rented out?

If, during the 5-year period ending on the date of sale, you owned the home for at least 2 years and lived in it as your main home for at least 2 years, you can exclude up to $250,000 of the gain ($500,000 on a joint return in most cases). However, you cannot exclude the portion of the gain equal to depreciation allowed or allowable for periods after May 6, 1997. This gain is reported on Form 4797. If you can show by adequate records or other evidence that the depreciation allowed was less than the amount allowable, the amount you cannot exclude is the amount allowed. Refer to Publication 523 , Selling Your Main Home and Form 4797 (PDF), Sale of Business Property for specifics on calculating and reporting the amount of the eligible exclusion.

How do you report the sale of a second residence?

Your second home is considered a capital asset. Use Form 1040, Schedule D (PDF) to report sales, exchanges, and other dispositions of capital assets.

Is the loss on the sale of your home deductible?

The loss on the sale of a personal residence is a nondeductible personal loss.

I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house, the basis won't be affected?

If you qualify to deduct expenses for the business use of your home, you can claim depreciation for the part of your home that is a home office. Generally, the part of your home that is a home office is depreciated over a recovery period of 39 years using the straight line method of depreciatiion and a mid-month convention. If you do not claim depreciation on that part of your home that is a home office, you are still required to reduce the basis of your home for the allowable depreciation of that part of your home that is a home office when reporting the sale of your home. For more information, refer to Publication 587, Business Use of Your Home.