What Are the Tax Consequences of an Inheritance Buyout?

An inheritance buyout occurs when multiple beneficiaries jointly inherit a property, and one heir decides to purchase the ownership shares from the others. This transaction allows one individual to consolidate ownership while providing the other heirs with cash for their portion of the asset. The process involves distinct tax considerations for both the selling and acquiring heirs, governed by rules that determine the property’s value and how any profit is treated.

Establishing the Tax Basis of Inherited Property

The foundation of the tax calculation in an inheritance buyout is the property’s tax basis. For inherited assets, the basis is the property’s fair market value (FMV) on the date of the original owner’s death. This is referred to as a “stepped-up basis” because the value is stepped up from the original purchase price paid by the decedent. This rule prevents heirs from being taxed on appreciation that occurred during the decedent’s lifetime.

Determining the FMV is a formal process that requires a professional appraisal. This appraised value becomes the starting point for all future tax calculations. For example, if three siblings inherit a home appraised at $600,000 on the date of their parent’s death, each heir’s individual stepped-up basis in their share is $200,000. This figure is the amount against which any future sale price is measured to determine a taxable gain or loss.

Tax Consequences for the Selling Heir

For the heir selling their share, the main tax consequence is the potential for capital gains tax. This tax is calculated on the difference between the proceeds from the buyout and the seller’s tax basis. The amount of tax owed depends on how much the property has appreciated since the date of the original owner’s death.

Consider a scenario where a buyout occurs shortly after the inheritance is settled. If the property was valued at $600,000 at the time of death, giving each of three siblings a $200,000 basis, and one sibling buys out another for $200,000, the selling heir has no taxable gain. The sale price equals their basis, resulting in a gain of zero.

A different outcome occurs if the buyout happens years later after the property has appreciated. Suppose the property, originally valued at $600,000, has appreciated to $660,000. If one sibling buys out another for their one-third share, the sale price would now be $220,000, resulting in a $20,000 taxable capital gain for the seller.

For tax purposes, property acquired from a decedent is considered to be held for more than one year, regardless of how long it was actually held. This means any gain on a subsequent sale is automatically treated as long-term. A gain will be taxed at the more favorable long-term capital gains rates of 0%, 15%, or 20%, depending on the seller’s income. The transaction must be reported to the IRS on Form 8949, and the resulting gain or loss is then carried over to Schedule D of Form 1040.

Tax Consequences for the Buying Heir

The heir who purchases the other shares does not face an immediate tax from the buyout itself. Instead, the transaction alters their tax basis in the property, which has future implications. The buying heir’s new, consolidated basis is calculated by adding the cost of the purchased shares to their own original basis.

Following the previous example, the buying heir started with their own one-third share, which had a stepped-up basis of $200,000. They then paid a sibling $220,000 to acquire their one-third share. The buying heir’s new total basis in the property becomes $420,000, representing their original basis plus the amount they paid in the buyout.

This higher basis is advantageous for the buying heir if they later decide to sell the property, as their taxable gain will be lower. For instance, if they and the remaining sibling sell the entire property for $750,000 in the future, the buying heir’s gain would be calculated on their two-thirds share of the proceeds ($500,000). This results in a taxable gain of $80,000, which is smaller than it would have been without the basis adjustment from the buyout.

Structuring the Buyout and Potential Complications

The structure of a buyout can introduce complications, especially when it occurs for less than the property’s fair market value. If an heir sells their $220,000 share to a sibling for $200,000, the $20,000 difference is generally considered a taxable gift from the seller to the buyer. The selling heir would be required to file a gift tax return, Form 709, to report this gift. However, it would likely fall under the annual gift tax exclusion ($19,000 for 2025) or the lifetime exemption, meaning no out-of-pocket tax would be due.

An alternative to a direct buyout is to handle the distribution within the estate administration process. Under this arrangement, the estate’s executor can distribute the property to one heir while distributing cash or other assets of equivalent value to the other heirs. This is known as a non-pro-rata distribution and can simplify the process by avoiding a separate sale between beneficiaries. The ability to do this depends on the terms of the will or trust and state law.

While this analysis centers on federal taxes, heirs must also consider state-level tax implications. Some states impose their own inheritance tax, which is paid by the person receiving the inheritance, or an estate tax, which is paid by the estate itself. These taxes are separate from federal capital gains tax and have their own rules and exemption amounts.