Inherited New Jersey Properties and the Capital Gains Tax

Determining which inheritances are taxed in New Jersey is a complex financial topic. Spouses, children, parents, and grandchildren are considered Class A beneficiaries and are exempt from paying inheritance tax on inherited property. However, if the property being inherited is physical real estate, there may be an additional financial aspect you haven’t planned for: capital gains tax.

Capital gains tax on inherited property works slightly differently from other assets. If you inherit a home and sell it, your entire profit will not be taxed. Instead, you and any co-beneficiaries will be taxed on the difference between the property’s sales price and its value on the market on the date of the owner’s death.

Before making any decisions about selling inherited property, beneficiaries should become familiar with both state and federal tax obligations. Each situation can be unique, depending on the type of property, the relationship to the deceased, and the estate's structure.

Understanding how capital gains tax applies to your inherited property is the key to making the most of your inheritance. Here, we will explore how to calculate the capital gains tax you will owe, solutions for reducing your tax burden, and how you should report the sale on your yearly tax return.

Do I owe capital gains tax on my inherited property?

It is important to clarify under what circumstances you owe capital gains tax. Capital gains tax will apply to your inherited property if you’ve made a capital gain—or in simpler terms, a profit— from the sale of the home. This happens when the sale price of the home exceeds its market value. The market value is assessed for the date the property passed into your ownership.

How is capital gains tax calculated for inherited properties?

You can determine your capital gains tax liability with a simple formula.

First, you need to determine the “tax basis” or “cost basis” of the inherited property. This number is the original purchase price of the property, including any known improvements. The good news is that when you take ownership of the property when you inherit, this amount is “stepped up.” This just means that instead of basing your capital gains liability on what the home was originally purchased for, you can base it on what the property is worth at the time of inheritance.

Here is an example:

Chris inherits his dad’s home after he passes away. His father purchased the home in 1980 for $150,000. Since then, his dad has invested about $50,000 in improvements to the property. This would give the property a tax basis of $200,000. However, because Chris has inherited the property, he is allowed to “step up” the tax basis to the home’s fair market value. To get this number, Chris has the property appraised, and it appraises for $350,000.

If Chris sells the property for equal to or less than the fair market value of the home ($350,000), he will owe no capital gains tax. If Chris decides to make improvements to the property to increase its sale price and sells the home for more, he will owe capital gains tax.

Let’s say Chris sells the property for $390,000. He will have a capital gain of $40,000, which will be the taxable portion.

How can I avoid paying capital gains tax on my inherited property?

If you have inherited a property and are considering selling, you should consider the consequences of capital gains taxes. There are some ways you can avoid the capital gains tax or at least reduce your tax liability. Here are some options:

1. The Section 121 Exclusion

Section 121 of the NJ tax code allows a taxpayer to exclude up to $250,000 for single filers or $500,000 for joint filers of capital gain from real estate sales. The caveat to this exemption is that you must have lived in the home as a primary residence for at least 2 of the 5 years prior to the sale of the home. To put it plainly, you must have the home as your primary residence for two years before you can use this exemption.

2. Deduct Selling Expenses from Capital Gains

You can also minimize your capital gains tax liability by subtracting any expenses you incurred fixing up the property for sale, including closing costs. So, if the fair market value of the home is $350,000 and you sell for $380,000, your capital gain is $30,000. However, if you spent $20,000 for closing and repairs, you can subtract this from the $30,000 to get your true capital gains of $10,000. This is the portion that will be taxed.

3. Wait One Year Before Selling

If you wait just one year to sell your inherited property, you will have access to more favorable tax rates. Owning the property for a year without selling it makes it a “long-term” capital gain under IRS rules. The idea is that during this year of ownership, you have incurred expenses for owning and maintaining the property. Because you have invested more in the property, you will owe less in capital gains taxes. However, if you sell the house within a year of inheritance, you can expect to pay more in capital gains tax.

How do capital gains need to be reported on my yearly tax return?

The year you sell the home is the year you will report your capital gains on your tax return. So, if you inherited the home in October 2023 but sold the home in April 2026, you will report the income on your 2026 tax returns.

To report the income on your tax return, follow these steps:

• Determine your capital gain (or loss) by subtracting your tax basis (the fair market value of the home) from the sales price.
• Report the sale with IRS Form Schedule D, which documents capital gains or losses.
• Copy your gain or loss on your Form 1040 (the primary document to file your annual income tax return).
• Make sure you attach the Schedule D form to your return at the time of submission to the IRS.

How can an estate planning attorney help me reduce my capital gains tax liability?

The complexities of capital gains tax, inheritance tax, and estate planning can be confusing, especially when navigating them for the first time. An estate planning attorney’s role is to provide clarity, guide you through the various strategies available, and help you make decisions that preserve your family’s assets.

An estate attorney can help you and your loved ones plan ahead to reduce or even eliminate your capital gains tax. There are specific trust structures, like an irrevocable trust, that can remove assets from your taxable estate and preserve tax benefits for beneficiaries. An estate attorney can also work with you to determine which assets may benefit from strategic gifting (low appreciation assets) and which assets should pass via inheritance (high appreciation assets) to minimize the overall tax burden of heirs.

In 2026, we expect some major changes to tax law, including potential reductions in exemptions. An estate planning lawyer can guide you as you navigate these changes and plan ahead to ensure that you are setting up your estate to maximize tax savings for your beneficiaries.

When you need an experienced estate planning and real estate attorney in New Jersey, Veitengruber Law is the right choice. We understand that estate planning can be overwhelming—but you do not have to do it alone. We can help you set up your family and loved ones for a smooth inheritance process. A thorough, professionally prepared estate plan is the best way to ensure your affairs are handled according to your wishes. We offer proven techniques to reduce or eliminate capital gains tax for your heirs.