Tax Treatment of an Inheritance

Tax Treatment of Inherited Money

What constitutes inherited money? Inherited money is when someone dies and they pass along either cash, real estate, stocks, an IRA account, or a brokerage account. We are going to look at what the tax treatment is and what you need to do to maximize your tax effectiveness for these properties or cash.What are the mechanics of inherited money? So, let's say your grandma has some money in bank accounts, she has a house that she owns, and maybe some stocks. You are grandma’s only living relative and she left all her assets to you in her will. All the cash, all her properties, all her stocks go to you. This is plain and simple when this is stated in her will. If she did not have a will then things get more complicated. All her assets will be held in her estate, and the estate will have to go through a process called probate in the courts. In this process, you work with the courts to figure out which assets go to which family members.The important thing with inherited property is that the person that died fully owns the property or assets before they passed away. This means that they did not transfer the title of their house to their decedents before they died. They did not send stocks over to their family members before they passed away. It means that they solely owned the property before they died and that's very important.I get a lot of questions from people that inherit assets. The first question is do they have to pay any taxes on this inheritance? And the answer is likely no, you do not have to pay any taxes. For example, you inherit $100,000 from your grandma, there are no taxes payable on this inherited money. Now let's say you inherited stock from your grandma. Do you have to pay taxes on the inheritance, on the actual mechanics of inheriting the stock? The answer is also no you don't. The only time that you would pay taxes on the stock is once it’s inherited and the stock then pays dividends, you'd have to pay taxes on the dividends you received. How about a house, would you have to pay taxes on a house that you inherited? The answer is no on the mechanics of inheriting the house. The last big thing I get questions about is life insurance proceeds. Let’s say grandma had life insurance policy of a million dollars. Will you have to pay taxes on those million dollars? If it's a legitimate life insurance policy, the answer is no you don't have to pay taxes on the life insurance proceeds.

Real Estate Inheritance and Step Up in Basis

You might have heard that there is a step up in basis when inheriting real estate. This is an important issue. The biggest question I get here is what you should do with an inherited property. Maybe you don't want to deal with the house. You don't want to live there because it's 2,000 miles from where you live now and from where your job is. Maybe it's not such a great house. Should you become a landlord and rent it out and make money that way? You should only become a landlord when you're ready to be a landlord. You don't want to be forced into being a landlord just because you inherited a house. The other option is to sell the home. People are afraid to sell an inherited property because they are afraid of paying taxes on the gains on the sale of the house. As you could imagine if your grandma purchased the house for $30,000 in the 1940s and now it might be worth $3 million, the taxes on the gains from that sale could be immense right? Not exactly. This is where that step up in basis comes into play. Basis is the cost of the property when it was first purchased plus any improvements made to the property. So, your grandma bought the house back in the 1940s for $30,000. That would mean her basis is $30,000. Now that grandma has passed away and her assets have been given to you, there's a provision in the tax code that allows for a step up in basis at the time of death of the owner. So, your grandma purchased the house for $30,000 in the 1940s and then she passed away last week. Last week the average market comp for the house is $3 million. That means at the time of death, you get a proper appraisal on the home of $3 million, that means that your actual tax basis as the person inheriting the house is now $3 million. If you sell the house for $3 million, you don't pay any capital gains because the capital gains are calculated by taking the selling price, minus the basis of the property, minus any selling expenses. If you're sell the house for $3 million, and your tax basis is $3 million, you pay no capital gains tax.This is the biggest reason you do not want to have real estate transferred or titled to you prior to a relative passing away. If grandma had transferred the title of the home to you prior to her death, it would be considered a “gift” and your basis would remain at the $30,000 that she originally purchased the home for and your capital gains at the time of sale would be $2,970,000 resulting in a significant capital gains tax.

Claiming a Step Up in Basis

The step up in basis also works with inherited stocks and the other types of appreciable assets. However, the step up in basis does not happen automatically. There is a Form 706 – United States Estate (and Generation-Skipping Transfer) Tax Return which needs to be filed to claim the step-up in basis. Basically, you've got to claim the step up in basis with the IRS so they don’t challenge the new basis when you sell the asset. The estate planning attorney or your CPA can file this tax return for you. This return lists the assets of the estate, the value or the basis of the assets, and the appraised basis of the assets at the time of death. Filing that form guarantees your step-up in basis with the IRS so you don't have any trouble down the road.We are here to help. If you’ve recently inherited assets and need help navigating the tax laws surrounding the inheritance, reach out to us at or email us at to schedule a complimentary consultation with one of our advisors.

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