When Might I Pay Capital Gains Taxes? - Slaton Schauer Law Firm, PLLC (2024)

Here at the Slaton Schauer Law Firm, PLLC, people often ask us about taxation of capital gains. Commonly, you may wonder if you are responsible for capital gains that accumulated during the life of the person that left you the inheritance. If they never realized a gain, the taxes would be unpaid, so it would be logical to assume that an inheritor would pay the capital gains tax.

In reality, this is not the case at all because the assets would get a stepped-up basis. For capital gains purposes, the basis would be equal to the value at the time that the inheritance was received. The tax would be levied if further gains are realized. As always, please note that this is not legal advice. We’re providing general information, but give us a call if you have specific questions!

Now, with that out of the way, let’s break this down a little further:

Capital Gains Rate

Since we are on the subject, we should share some other information about the capital gains tax. For tax rate purposes, gains are broken up into two different categories: short-term gains that are realized less than a year after the acquisition, and long-term gains.

The rate at which the long-term capital gains tax is applied depends on the income level of the person that realized the gain. Individuals that claim $40,400 or less are exempt from the tax, and there is 15 percent rate for those that earn more than this much but less than $445,850.

Filers that are in the highest income group pay 20 percent right now, but that may change at the beginning of the year. There is a tax proposal in Congress that would increase the long-term capital gains rate to 25 percent for those that are making $400 a year and more.

Income Taxes

Your heirs will not pay income taxes on their inheritances under most circ*mstances because your estate is essentially a remainder that is left after you pay taxes. Another imposition would be double taxation, and this would not be fair.

There are exceptions when no taxes have been paid on assets that will be distributed. Distributions of the earnings that are generated by the principal in a trust would fit this description. They would be taxable, but distributions of the principal would be tax-free.

Traditional individual retirement accounts are funded before taxes have been paid on the income, so distributions to the original account holder are taxable. This also applies to the beneficiary.

Roth IRA contributions are made after taxes have been paid, so the distributions are not subject to taxation.

Estate Taxes

Another type of tax that can enter the picture when assets are changing hands after someone dies is the federal estate tax. This tax is significant because it carries a 40 percent rate, but it is only a factor for very high net worth individuals.

There is an exclusion that can be used to transfer a certain amount tax-free before the tax would be levied on the portion that exceeds the exclusion. At the time of this writing in 2021, it is $11.7 million, but it would go down to just over $6 million next year if a pending piece of legislation is passed.

You don’t have to worry about paying estate taxes on transfers to your spouse if you are married to an American citizen, because there is an unlimited marital deduction.

There is a gift tax that is unified with the estate tax, and this prevents you from giving tax-free gifts while you are living to avoid the estate tax.

There are a total of 12 states in the union that impose state-level estate taxes, but the great state of Texas is not in this group. However, if you happen to own property in a state with an estate tax, the tax would apply to you if its value is greater than the exclusion in that state.

It should be noted that the state-level exclusions are lower than the federal exclusion. Oregon has an estate tax with a $1 million exclusion, and this is the level in Massachusetts as well.

There are five states that have state-level inheritance taxes. This is a tax that is levied on distributions to each individual nonexempt inheritor when one estate is being administered.

Texas is not in this group, but it would be applicable if you inherit property in a state that has an inheritance tax, and there are no large exclusions. The good news is that close relatives like spouses, children, parents, grandchildren, and siblings are typically exempt.

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