Capital Gains Taxes

Are Inheritances Taxable?

Inheritances come in all sizes and shapes. People inherit financial accounts, real estate, jewelry and personal items. However, whatever kind of inheritance you have, you’ll want to understand exactly what, if any, taxes might be due, advises the article “Will I Pay Taxes on My Inheritance” from Orange Town News. An inheritance might have an impact on Medicare premiums, or financial aid eligibility for a college age child. Let’s look at the different assets and how they may impact a family’s tax liability.

Bank Savings Accounts or CDs. As long as the cash inherited is not from a retirement account, there are no federal taxes due. The IRS does not impose a federal inheritance tax. However, there are some states, including Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania, that do have an inheritance tax. Speak with an estate planning attorney about this tax.

Primary Residence or Other Real Estate. Inheriting a home is not a taxable event. However, once you take ownership and sell the home or other property, there will be taxes due on any gains. The value of the home or property is established on the day of death. If you inherit a home valued at death at $250,000 and you sell it a year later for $275,000, you’ll have to declare a long-term capital gain and pay taxes on the $25,000 gain. The cost-basis is determined, when you take ownership.

Life Insurance Proceeds. Life insurance proceeds are not taxable, nor are they reported as income by the beneficiaries. There are exceptions: if interest is earned, which can happen when receipt of the proceeds is delayed, that is reportable. The beneficiary will receive a Form 1099-INT and that interest is taxable by the state and federal tax agencies. If the proceeds from the life insurance policy are transferred to an individual as part of an arrangement before the insured’s death, they are also fully taxable.

Retirement Accounts: 401(k) and IRA. Distributions from an inherited traditional IRA are taxable, just as they are for non-inherited IRAs. Distributions from an inherited Roth IRA are not taxable, unless the Roth was established within the past five years.

There are some changes coming to retirement accounts because of pending legislation, so it will be important to check on this with your estate planning attorney. Inherited 401(k) plans are or eventually will be taxable, but the tax rate depends upon the rules of the 401(k) plan. Many 401(k) plans require a lump-sum distribution upon the death of the owner. The surviving spouse is permitted to roll the 401(k) into an IRA, but if the beneficiary is not a spouse, they may have to take the lump-sum payment and pay the resulting taxes.

Stocks. Generally, when stocks or funds are sold, capital gains taxes are paid on any gains that occurred during the period of ownership. When stock is inherited, the cost basis is based on the fair market value of the stock or fund at the date of death.

Artwork and Jewelry. Collectibles, artwork, or jewelry that is inherited and sold, will incur a tax on the net gain of the sale. There is a 28% capital gains tax rate, compared to a 15% to 20% capital gains tax rate that applies to most capital assets. The value is based on the value at the date of death or the alternate valuation date. This asset class includes anything that is considered an item worth collecting: rare stamps, books, fine art, antiques and coin collections fall into this category.

Speak with an estate planning attorney before signing and accepting an inheritance, so you’ll know what kind of tax liability comes with the inheritance. Take your time. Most people are advised to wait about a year before making any big financial decisions after a loss.

Reference: Orange Town News (May 29, 2019) “Will I Pay Taxes on My Inheritance”

Estate Planning Hacks Create More Problems

“My idea: put our accounts in my wife’s name and put the land in our children’s names. The way I figure it, when something happens to me, they won’t need to do any of that courtroom mumbo jumbo that costs a few thousand dollars.”

The estate planning attorney in this gentleman’s neighborhood isn’t worried about this man’s plan to avoid the “courtroom mumbo jumbo.” It’s not the first time someone thought they could make a short-cut work, and it won’t be the last. However, as described in the article “Estate planning workaround idea needs work” from My San Antonio, the problems this rancher will create for himself, his wife, and his children, will easily eclipse any savings in time or fees he thinks he may have avoided.

Estate Planning Hacks
Estate planning hacks, or “work-arounds” almost always end up costing the family more time and money in the end.

Let’s start with the idea of putting all the man’s assets in his wife’s name. For starters, that means she has complete control and access to all the accounts. Even if the accounts began as community property, once they are in her name only, she is the sole manager of these accounts.

If the husband dies first, she will not have to go into probate court. That is true. However, if she dies first, the husband will need to go to probate court to access and claim the accounts. If the marriage goes sour, it’s not likely that she’ll be in a big hurry to return access to everything.

Another solution: set the accounts up as joint accounts with right of survivorship. The bank would have to specify that when spouse dies, the other owns the accounts. However, that’s just one facet of this estate planning hack.

The next proposal is to put the land into the adult children’s names. Gifting the property to children has a number of irreversible consequences.

First, the children will all be co-owners. Each one of them will have full legal control. What if they don’t agree on something? How will they break an impasse? Will they own the property by majority rule? What if they don’t want to honor any of the parent’s requests?  In addition, if one of them dies, their spouse or their child will inherit their share. If they divorce, will their future ex-spouse retain ownership of their shares of the property?

Second, you can’t gift the property and still be an owner. The husband and wife will no longer own the property. If they don’t agree with the kid’s plans for the property, they can be evicted. After all, the parents gave them the entire property.

Third, the transfer to the children is a gift. There will be a federal gift tax return form to be filed. Depending on the value of the property, the parents may have to pay gift tax to the IRS.  Because the children have become owners of the property by virtue of a gift, they receive the tax-saving “free step-up in basis.” If they sell (and they have that right), they will get hit with capital gains taxes that will cost a lot more than the cost of an estate plan with an estate planning attorney and the “courtroom mumbo jumbo.”

Finally, the property is not the children’s homestead. If it has been gifted it to them, it’s not the parent’s homestead either. Therefore, they can expect an increase in the local property taxes. Those taxes will also be due every year for the rest of the parent’s life and again, will cost more over time than the cost of creating a proper estate plan. Since the property is not a homestead, it is subject to a creditor’s claim, if any of the new owners—those children —have a financial problem.

Estate plans exist to protect the current owners and their heirs. If the goal is to keep the property in the family and have the next generation take over, everyone concerned will be better served by sitting down with an estate planning attorney and discussing the many different ways to make this happen.

Reference: My San Antonio (April 29, 2019) “Estate planning workaround idea needs work”

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