Tax on Inheritances Gifts

Gift and Inheritance Issues

Taxpayers should be mindful of the potential tax consequences when inheriting money and other property.  Generally, inheritances will be income tax free, however there are certain circumstances that will trigger a liability.  Taxes to consider include income tax on deferred retirement tax accounts and capital gains on resale of inherited property.  Important tax rules relate to gifting as well.

Inherited Retirement Plans

If your inheritance includes a tax deferred retirement account (IRA or 401K), there are tax consequences and special rules for distributions.  The rules depend on your relationship to the account holder and type of plan inherited.  If you chose to liquidate the account, the entire balance will be taxable at your individual tax rate.  This is because the account is tax deferred, in that the owner has not paid any taxes on the earnings and received a tax deduction for their contribution.

If you are non-spouse beneficiary, you must take withdrawals over the next 10 years following the death of the account holder to deplete the account.  You should transfer your share of the retirement plan to a designated inherited account.  Spouses, minor children, disabled beneficiaries and recipients not more than 10 years younger than the decedent can stretch their payments over their life expectancy instead of ten years.  Failure to comply with the ten-year liquidation rule will expose the beneficiary to penalty of 50% of the account balance remaining after ten years.

Qualified distributions from Roth IRA accounts are generally tax free as an inheritance if the account holder was over age 59 and a half.  Though distributions need not be taken, the account must still be liquidated within ten years.  In any event, the distributions would be tax free.

Basis of InheritanceGain on Sale of Inherited Property

Many taxpayers have questions on the tax consequences of selling inherited assets.  There be capital gains taxes due on your subsequent sale of inherited property.    Basis in property received from a decedent is generally the fair market value (FMV) at the date of death.  This basis is stepped up from decedent’s original cost basis.  So, if you sell inherited stock for $12 per share (original owner paid $5 per share) with FMV $10 at death, your gain is $2 per share.   Accordingly, the beneficiary’s capital gains tax is minimized.

Gift Tax Rules

A gift is a transfer to and individual (either directly or indirectly) where full consideration is not received in return.  Making a gift does not ordinarily affect your tax return, unless making a gift to an IRS recognized charitable organization.  The donor (person making the gift) would pay the tax on gifts made, if any.  With a little planning and knowing the rules, most taxpayers are able to make gifts without triggering tax due or possibly even the gift tax return filing requirement.   The most common approach is through the annual gift tax exclusion, which is $15,000 per donee (person receiving the gift), and applies to spouses for a combined total of $30,000.  By way of example, to a couple could give their married child up to $60,000 per year provide for home down-payment.  Also, educational and medical expenses paid directly to the third party are excludable, in any amount.  It is important to document any gifts received, as the IRS may assume this is income without signed statement from the donor.

Though not taxable, there are important disclosure requirements for gifts received by foreign persons.  Foreign persons include non-resident aliens, foreign estates, corporations, partnerships and domestic trusts owed by foreign persons.  In my practice, I field many inquiries from taxpayers who are receiving gifts from foreign relatives to buy property here in U.S.  If the gift is over a certain threshold ($100,000 for individuals), you must disclose the gift on your tax return or face significant penalties.