Ask the Expert: Taxes on an inherited house

You've written that when people inherit a house, they receive it at the market value it was worth when its deceased owner died. Would that be different for my heirs if I have a life estate in the house? Will their tax liability be significantly higher at the time of my demise because I kept a life estate when I transferred the house to them?

No. They'll inherit the house at its market value at the time of your death. When they sell it, they'll only owe taxes on any increase in that value since then. If the house is worth $1.5 million when you die, for example, and they later sell it for $1.9 million, they'll owe taxes on $400,000.

It would be different if you'd simply given the house to your children. In that case, they'd owe taxes on sale proceeds that exceeded your original purchase price. If you originally paid $100,000 and they sold it for $1.9 million, for example, they'd owe taxes on $1.8 million.

But you kept a life estate — legal jargon for the right to continue living there. Tax law (Section 2036(a) of the Internal Revenue Code) says that because you retained that right, the full value of the house will remain in your taxable estate when you die, says Alan E. Weiner, a Plainview tax accountant. And section 1014 of the Internal Revenue Code says that when the value of a house is included in its deceased owner's taxable estate, the house is inherited at its fair market value at the time of his or her death. This is true even if your estate doesn't actually incur a tax, adds Weiner.

The bottom line

A house in which the deceased owner retained a life estate is inherited at its market value.

More information

law.cornell.edu/uscode/text/26/2036

irc.bloombergtax.com/public/uscode/doc/irc/section_2036