Planning for Real Estate Inheritance: Tax Essentials

4 November 2025

Passing down real estate to your loved ones is a meaningful and valuable gift. But without proper planning, taxes can take a bite out of that inheritance, potentially leaving your heirs with more headaches than benefits. So, how can you ensure a smooth, tax-efficient transfer of property? Let’s break it all down in a way that makes sense, focusing on the key tax essentials you need to know.

Understanding Real Estate Inheritance Taxes

Before diving into the specifics, let's clarify what real estate inheritance taxes actually are. When you pass away and leave property to your heirs, various taxes may come into play, including:

- Estate Tax – A federal tax on the total value of a deceased person’s estate before distribution to heirs.
- Inheritance Tax – A state-level tax that some states impose on those who inherit property.
- Capital Gains Tax – A tax on the profit made if the property is later sold by the heir.

Each of these taxes can impact how much your heirs actually receive, so planning ahead is crucial.

Estate Tax: Will Your Heirs Owe It?

What Is the Estate Tax?

The estate tax is a federal levy on estates exceeding a certain threshold. As of 2024, estates under $13.61 million are exempt from federal estate taxes. If your estate is worth more than this, anything above the exemption is taxed at 40%.

How to Reduce Estate Tax Liability

If your estate approaches or exceeds the exemption limit, here are some strategies to minimize estate taxes:

- Gifting Assets Early – The IRS allows individuals to gift up to $18,000 per year per recipient (as of 2024) without triggering gift taxes.
- Creating Trusts – Irrevocable trusts can remove assets from your estate, reducing the taxable amount.
- Charitable Donations – Leaving a portion of your estate to charity can help reduce the taxable amount.

If your estate is smaller than the federal exemption, you likely won’t have to worry about federal estate taxes. However, some states impose estate taxes at much lower thresholds, so check local laws.

Inheritance Tax: Do Your Heirs Have to Pay?

Unlike estate tax, inheritance tax is paid by the person receiving the inheritance, not the estate itself. The good news? The federal government doesn’t impose an inheritance tax, but a handful of states do, including:

- Iowa
- Kentucky
- Nebraska
- New Jersey
- Pennsylvania
- Maryland

How Much Will the Inheritance Tax Be?

Rates vary by state and depend on the heir’s relationship to the deceased. Close family members (spouses, children) often pay little or nothing, while distant relatives or unrelated individuals may face rates as high as 18%.

Avoiding or Minimizing Inheritance Taxes

If your heirs live in a state with an inheritance tax, consider these options:

- Gifting Property Before Death – If you transfer ownership before passing away, your heirs may avoid the tax entirely.
- Moving to a Tax-Friendly State – If inheritance taxes are a concern, relocating to a state without one can help.

Capital Gains Tax: What Happens When the Heirs Sell?

One of the biggest tax surprises comes after inheriting a property. If heirs decide to sell, they could face capital gains tax on the difference between the selling price and the property’s original cost.

What Is Step-Up in Basis?

Fortunately, heirs benefit from a tax rule called the step-up in basis. This means the property’s value is "reset" to its fair market value at the time of the original owner’s death.

For example:
- You bought a house for $200,000 years ago.
- At the time of your passing, it’s worth $500,000.
- Your heirs inherit it at the $500,000 value, not the original $200,000 purchase price.

If they sell it at $510,000, they'd only owe capital gains tax on the $10,000 increase—not the $310,000 difference from the original purchase price!

Trusts vs. Wills: Which One Is Better for Real Estate Inheritance?

When planning to pass down property, most people use either a will or a trust. Each method has its pros and cons.

Wills: Simple but Subject to Probate

Pros:
✅ Straightforward and easy to create
✅ Clearly states who inherits the property

Cons:
❌ Requires probate (a legal process that can take months or years)
❌ May result in higher taxes for heirs

Trusts: Avoid Probate and Offer Tax Benefits

Pros:
✅ Bypasses probate, meaning heirs receive property faster
✅ Can reduce estate tax burdens
✅ Offers more control over how and when assets are distributed

Cons:
❌ Requires legal setup and costs more upfront
❌ More complex than a will

For those with significant real estate assets, an irrevocable trust can be a smart move to minimize taxes and avoid probate hassles.

Gifting Real Estate: A Smart Tax Strategy?

Some people consider gifting their real estate to heirs before they pass away to avoid inheritance taxes. However, this can be tricky.

Pros of Gifting Property Early

✔ Avoids probate
✔ Reduces estate tax burden
✔ Helps heirs take ownership sooner

Cons of Gifting Property

❌ Loses the "step-up in basis" (heirs inherit the original purchase price, not the market value)
❌ Could trigger gift taxes if the value exceeds the annual exemption limit

If you’re considering gifting real estate, consult a tax professional beforehand to weigh the pros and cons in your specific situation.

Planning Ahead: Steps to Take Now

Want to ensure your heirs inherit your property with minimal tax stress? Here’s what to do right now:

✅ Review Your Estate Plan – Check if your property value requires tax planning.
✅ Consider a Trust – Especially if you want to avoid probate or estate taxes.
✅ Use the Annual Gift Tax Exclusion – If gifting property, stay within the IRS limits to avoid taxes.
✅ Talk to an Estate Planner – Professional advice can save your heirs from unexpected tax bills.

By taking these proactive steps, you can secure your legacy while ensuring your heirs receive the full benefit of their inheritance.

Final Thoughts

Real estate inheritance can be a huge financial boost for your loved ones—if you plan wisely. Taxes on inherited property can be complex, but with the right strategies, you can minimize the financial burden on your heirs. Whether it’s using trusts, taking advantage of step-up in basis, or gifting property early, proactivity is key.

So, don’t wait. Start planning today to ensure your family benefits from your real estate legacy without unnecessary tax stress.