Q: We own a vacation home in Vermont that we are leaving to our adult son in our wills. The home cost $95,000 and is now worth around $300,000. We've made about $15,000 in improvements over the years. Will our son owe any income tax if he inherits the home in the next few years? M.M., Stamford, Conn.
A: Not necessarily. First of all, he won't pay any tax until he sells the home. In addition, your son is entitled to a step-up in basis to the home's current fair market value as of the date he inherits it. So if he turns around and sells the home right away—presumably at around $300,000—he will face little or no income tax because he won't have any taxable gain. But if he holds the property for several years before selling, he will owe tax on the difference between the sales price and the stepped-up basis. That assumes your son won't use the property as his principal residence for at least two years before selling. If he does live in the house for at least two years, he would qualify for the $250,000 home-sale gain exclusion ($500,000 if he is married). In that situation, he would almost certainly not have any taxable gain when he sells.