After a loved one’s death, the last thing you want to face are financial questions. Receiving an inheritance might make you feel unsure where to turn for answers. Asking a professional can be expensive, and turning to your friends is awkward because they will know about your newfound wealth. Here then are some helpful answers about the next steps regarding your newly acquired assets, property, or stocks.
Is my new money taxable now?
For Federal income tax purposes, your inheritance is not taxable. However, in some states the beneficiary (the individual who received the asset or property) may owe taxes, also known as an inheritance tax. An inheritance tax is a state tax based on the assets received from someone who has passed away. Currently MD, NJ, PA, NB, IA, and KY have inheritance taxes. The tax rate is based on the state where the beneficiary resides, not the deceased’s state of residence.
After the executor distributes the assets to the estate’s beneficiaries, then the inheritance tax is calculated. Each beneficiary’s inheritance tax is calculated separately. The rate varies from 1% to 18% on the value of your inheritance. Based on your relationship with the deceased, the state could reduce the value on which your inheritance tax is based. A common example is that spouses do not pay inheritance taxes. Children or other dependents may find all or a portion of their inheritance is exempt from the tax, depending on the state. Most commonly, the highest inheritance tax is paid by beneficiaries who are not closely related to the decedent.
How is inherited property taxed on the state level?
A number of states also impose an estate tax. The difference between estate tax and inheritance tax is “who has to pay the tax.” Estate taxes are calculated on the deceased’s assets and property, before distributions are made to beneficiaries. The rate of estate state tax varies from .08% – 20%. At the Federal level, few estates actually pay an estate tax since the value needs to exceed $11.58M per person (as of 2020). For those estates over $11.58M the estate tax is 40%. This exemption drops to $5.79M in 2026, unless Congress intervenes. The estate tax is based on fair market value at death, not what the deceased paid for the assets.
Currently thirteen states/districts have an estate tax. Estates pay these state-based taxes depending on the size of the estate, and size limits vary widely. For instance, estates pay taxes in MA and OR if the estate value exceeds $1M; in NY, estate values must exceed $5.74M before they are taxed. As of 2020, CT, DC, HI, IL, ME, MD, MA, MN, NY, OR, RI, VT, and WA all have estate taxes. It’s important to note that Maryland has both an estate and inheritance tax, and is currently (as of 2020) the only state with both.
Will my new money be taxable later?
You may avoid state inheritance and estate taxes, however, almost all estates will have to deal with the question of capital gains. At the date of death, estate assets receive a “step up” in cost basis. For example, let’s assume your mother purchased a house in 2001 for $300k. Then, in 2020, she passed away when the home was valued at $1M. For tax purposes, your “basis” in the property is $1 million, meaning you do not have to pay any gains taxes on the appreciation. Later on, if you were to sell the property in 2020 for $1.1M, the taxable gain is $100k.
This updated basis is the new baseline for determining potential capital gains taxes moving forward. Asset appreciation above the basis after the death date is considered a long-term taxable gain. (Unlike regular asset or property sales, inherited assets always are considered long term, regardless of how long the beneficiary actually holds the asset.) If the asset is sold for less than the basis, it is a loss, and no tax is due. If the asset is sold above the basis, then there is a gain, and tax may be due. The amount due depends on your individual tax situation.
Let’s explore another example of inherited assets and the potential tax due. If you inherit 100 shares of Apple from your father worth $250 per share on his date of death, then $25,000 is your basis — even if your dad only paid $1,000 for the shares many years ago. If you sell the shares when they reach $300 per share ($30,000), your long-term capital gain is $5,000, or $50 per share. The gain flows to you on your personal tax return (1040), schedule D. Federal long-term capital gains tax rates range from 0% to 20%, depending on your taxable income. States also assess capital gains taxes and could exceed 20% depending on your state of residence.
Is it possible to capture a loss on an inheritance?
On the flip side, there are a few special rules around capital loss on an inherited property. If the property has decreased in value since the inheritance, the beneficiary can capture a loss if the property is sold to an unrelated party. However, if the property is sold to the executor of the estate or other beneficiaries then you cannot capture a loss. Only if you sell the property to an unrelated party of the estate (i.e. a stranger) can you capture the loss.
Who can I ask for help when navigating my inheritance?
Before selling any assets or property it is important to consult with a financial advisor and tax accountant to determine your best path forward. They can advise you on future tax liability from the potential sale and navigate the optimal way to utilize your newfound wealth. For further questions around these sensitive topics, reach out to an Abacus advisor who can help you support you.
Disclosure: This material is not intended to serve as personalized tax, legal, and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Abacus Wealth Partners, LLC is not an accounting firm. Please consult with your tax professional regarding your specific tax situation when determining if any of the mentioned strategies are right for you.
