Inheritance taxes are complicated. Your inherited assets—property, stocks, investment accounts, etc.—may be subject to taxes, and there are specific tax rules for each type of asset or account. Before you start selling assets, make sure you know the rules.
The first thing to understand is the type of taxes that can apply to an inheritance; there are both estate taxes and income taxes.
Estate Taxes vs. Income Taxes
Estate taxes apply to the total value of everything you own: real estate, stocks, bonds, retirement accounts, deferred annuities, businesses, farms, and even the death benefit values of any life insurance policies owned by the person who passed away.
With current 2024 estate tax rules, federal estate taxes will only impact singles with an estate of $13.6M or more or married couples (if they’ve done proper planning) with an estate worth $27.22M or more. Estates with values below these limits are exempt from federal estate taxes. These limits are indexed to inflation, so they rise each year. Needless to say, federal estate taxes will not affect most of us.
Caution. Some states still assess a separate state-level estate or death tax. You should research the rules for the state the decedent lived in.
Note. The federal estate tax limit exemption amount may get cut in half in 2026 when the 2016 TCJA tax changes expire.
When we say ‘inheritance taxes’ we’re not talking about estate taxes. We’re talking about various types ofincome taxesowed on inherited assets.
Regardless of the value of the decedent’s estate, you may still owe income taxes on assets that were left to you. Here’s a checklist of the most common assets that beneficiaries inherit and how the income taxes work.
Income Taxes on Inherited Property
The sections below cover the taxation of inherited IRAs and real estate. Income taxes can apply to inherited retirement accounts, and capital gains taxes may apply to inherited stocks, mutual funds, and real estate.
Inherited IRAs
If you already have a traditional IRA, 401(k) or other tax-deferred accounts like a 403(b) or SIMPLE plan, you know that money inside these types of accounts is pre-tax. When you inherit such accounts and withdraw money, the amount withdrawn is considered taxable income. Some people cash in these accounts and are surprised when they get the bill for the taxes owed. Ouch. That’s not the kind of surprise you want to get.
Prior to 2020, with an inherited IRA, you could take required distributions based on your life expectancy. If you desired, you could withdraw more than this amount, but not less. With this approach, you would have only had to withdraw Required Minimum Distributions (RMDs) each year, allowing you to stretch the income and taxes on this inheritance. It does not work that way anymore.
With the passing of the Secure Act on December 19, 2019, a non-spousal beneficiary will no longer be able to take advantage of life expectancy RMDs and extended tax deferral. Instead, they are required to withdraw the inherited account within ten years, which could result in putting a beneficiary in a higher tax bracket.
Inherited 401(k)s
You must pay income tax on the amount you withdraw from an inherited 401(k). Spouses, minor children, and beneficiaries with disabilities can still withdraw RMD’s over their life expectancy. However, for non-spousal beneficiaries, due to the SECURE Act of 2019, the same rules for IRAs also apply to 401(k)s.
Inherited mutual funds and stocks
There are different tax rules for inherited mutual funds and stocks that are not held inside retirement accounts. Typically, when you sell a stock or fund, you pay capital gains tax on any gain since you bought it. The amount you originally bought it for is called yourcost basis.
When you inherit these types of assets the cost basis for the beneficiary becomes the fair market value of the stock or fund at the time of the decedent’s passing. This is referred to as a “step-up” in cost basis.
Example. Your parent bought a stock for $100 and it was worth $200 at their death. For tax purposes, you can “step-up” the cost basis to $200.
You can choose the fair market value of the fund or stock to be the date of the decedent’s death, or the fair market value as of six months after death. Whichever date you choose, you must use it consistently across all the assets you inherited. To use an alternate valuation date, you must make an election onIRS Form 706, within one year of the due date of the federal estate tax return, including extensions.
When you sell the asset, you will either have acapital gain or a lossdepending on the difference between the cost basis and the asset’s value when you sell it. To estimate the taxes on cashing in inherited accounts, you can run atax projectionto see what taxes you will pay if you go that route.
Inherited home/property
When you inherit a home, the cost basis for tax purposes is either the home’s value on the decedent’s date of death or the fair market value six months later if you chose that alternate valuation date.
Example. You inherit a house worth approximately $200,000 at the decedent’s time of death and you sell it eight months later for $220,000. You will have $20,000 of capital gains to report on your tax return. However, and this is very important, you might be able to exclude up to $250,000 of gain if the deceased lived in the home for at least two of the last five years. Unfortunately, if there is a loss on the sale, you cannot use it as a deduction.
A good tax preparer can help you figure all this out.
Warning. If the decedent added you as a joint property owner, you might forfeit some of your step-up in cost basis. In the example with the home worth $200,000, let’s assume the decedent was your parent, and they bought the house for $100,000. Thinking they were doing the right thing, they added you to the home’s title. Now, upon their passing, you only get a step-up on half the home’s value. Their half of the home has a basis of $100,000, but your half has a basis of $50,000, so for tax purposes, your basis is $150,000. Now, when you sell it, you owe taxes on $70,000 instead of only $20,000. Yikes!
Artwork and jewelry
If you inherit artwork, jewelry, or collectibles and sell them, you will have to pay taxes on the net gain of the sale. Upon the sale of inherited collectibles, there is a hefty 28% capital gains tax rate, as compared to the 15% to 20% that applies to most capital assets.
To determine the cost basis, use the value at the date of death or the alternate valuation date (whichever you’ve chosen to apply consistently across all the inherited property.) The difference between the sale price and the cost basis is subject to taxation. Items in this category include anything that is considered an item worth collecting. Generally, rare stamps, books, coins, art, fine wine, glassware, and antiques all fall under the collectibles umbrella.
Trust Accounts
When you inherit a trust account, the rules get more complicated. If it was a revocable living trust, with tax filings under the decedent’s Social Security number, likely all the tax rules described above apply. However, if you inherit assets titled in an irrevocable trust, with it’s own tax id number, the step-up in basis rules may not apply. Most people fund irrevocable trusts in an attempt to remove assets from a large estate. While this structure shelters the growth of the asset from estate taxes, the step up in basis to date-of-death value does not apply, and so capital gains taxes may apply. Expert tax advice in these situations is advised.
A final few words of advice
After a loved one passes, you are in mourning. You are likely to be vulnerable not only because of your emotional state but simply because you are learning about new and complicated topics. Don’t be fooled by creditors who may attempt to collect debts from family members of a deceased person. These claims should be made against the estate, not against you.
You may also inadvertently fall victim to someone, who, learning of your recent windfall, tries to sell you investments or insurance products. Only make investment or insurance purchases after going through a comprehensive financial planning process.
Tax laws are complex. If you expect to receive an inheritance, this may be the perfect time to start searching for a qualified professional to help you decide what to do based on your situation and future goals.
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