We are going to cover the matter of real property as part of your taxable estate in this post. In order to get there, we have to provide a general overview about taxes on inheritances, so we will start there and proceed to the question of property ownership.
Income Taxes on Inheritances
Generally speaking, inheritances are not considered to be taxable income by the IRS or Connecticut state tax authorities. This is because assets that comprise your estate are left over after you paid your taxes throughout your life.
An exception to the rule would be undistributed earnings generated by assets in a trust. In addition, if you leave a traditional individual retirement account to a beneficiary, distributions would be taxable.
Estate and Gift Taxes
High-net-worth individuals can be exposed to estate taxes. On the federal level, the estate tax exclusion is $13.61 million. This is the amount that can be transferred tax-free, and anything that exceeds this amount would be subject to taxation. The maximum rate of the tax is 40 percent.
Connecticut is one of the 12 states with state-level estate taxes. The exclusion in our state is equal to the federal exclusion, but most states with estate taxes have lower exclusions.
You can’t give away all of your assets while you are living to avoid the federal estate tax because there is also a federal gift tax. It is unified with the estate tax, so the $13.61 million exclusion applies to large gifts along with your estate.
On the state level, there is also a gift tax in Connecticut. Our state is the only state in the union with a gift tax. Connecticut used to have a graduated transfer tax rate, but a 12 percent flat rate was established in 2023.
Home Ownership
Now that we have set the stage appropriately, we can address the matter at hand. If you own a home, it is part of your estate as it applies to estate taxes. The transfer of your home to beneficiaries would not be subject to income taxes.
Your home would also get a stepped-up basis when it is transferred. This means that the inheritors would not be required to pay capital gains taxes on the appreciation that accumulated while you were living.
Since property is extremely valuable in the Westport, Connecticut area, the value of your home could eat up a significant portion of your estate tax exclusion. Plus, the exclusion is going down to $5.49 million indexed for inflation at the beginning of 2026 when the Tax Cuts and Jobs Act of 2017 sunsets.
Estate Tax Efficiency Strategies
There are things that you can do to mitigate your exposure if estate taxes are source of concern. With regard to your home, you could potentially convey it into a qualified personal residence trust. When you do this, you are removing the value of your home from your taxable estate.
You would live in the home as usual for a period of time that you determine when you draw up the trust agreement. This is referred to as the “retained interest period.”
When the IRS determines the taxable value of the gift, they consider the fact that the recipient will not assume ownership of the gift for a number of years. On top of this, the basis will be the value of the home at the time that it is transferred to the trust.
Ultimately, when the transfer takes place, the taxable value of the home will be considerably lower than the actual value.
We Are Here to Help!
Our firm can help if you would like to implement a tax efficiency strategy, and we can work with you to create a tailor-made plan if taxation is not a source of concern. To get started, call our Westport or Glastonbury, CT estate planning offices at 860-548-1000 or send us a message through our contact page.
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