Consider the Tax Aftermath of Inheritance

Physician's Money Digest, March31 2004, Volume 11, Issue 6

Many people don't understandwhat happens when they inherit money, property,or assets from a friend or relative. The resulting responsibilitieson the inherited money can be difficult to comprehend.

Representative Duties


When someone dies, the personalrepresentative named in their will, orthe administrator of the estate appointedby the probate court if there is nowill, is responsible for making an inventoryof all of the deceased person'sassets, including personal property,investments, real estate, etc. Once theinventory is complete, the personal representativethen determines if any estatetaxes are owed to the government. Theconcept behind the estate tax is toredistribute the assets of wealthy individuals. As of 2004, estates under$1.5 million are generally not subject tofederal estate taxes.

If estate taxes are due, the personalrepresentative is responsible for raisingthe cash to pay those taxes to the federalgovernment and, in some cases, thestate government. The personal representativeis also responsible for filingincome tax returns for the deceased personfor the year in which they died andpaying any federal and state incometaxes due. Typically, all of this is donebefore anything is distributed to thosepersons or institutions designated toinherit under the will, or state law incases where there is no will. Therefore,if you inherit money or property, youwill not owe any additional estate orincome taxes on your inheritance. Infact, the federal tax law specificallystates that gross income does notinclude money or the value of propertyacquired by inheritance, whether undera will or not.

There are a couple of exceptions,including receiving distributions from aretirement plan or an annuity. If youreceive distributions from a retirementplan, such as an IRA, those distributionswill be subject to federal and stateincome taxes. This is because the ownerreceived income tax deductions fortheir contributions to the retirementaccount and no income taxes have everbeen paid on that money. Depending onthe circumstances under which youinherit the retirement account, you maybe forced to pay the income taxes asquickly as 5 years from the date ofdeath of the donor. While the incometax rules differ somewhat, you will besubject to income taxes on inheritedannuities as well.

Income Tax Consequences

Most people are not aware that ifyou inherit a highly appreciated asset,such as real estate or stocks, then youreceive a stepped-up basis for income taxpurposes. This is generally the asset's fairmarket value as of the date of death ofthe decedent. As an example, let's saythat you inherit land that your fatherpaid $10,000 for 30 years ago, but onthe day he died, the land is worth$100,000. Because of the step-up inbasis tax rules, that $90,000 gain is forgiven,and as the inheritor of the property,you could sell it the next day for$100,000 and owe no taxes on the sale.

It is important to note two additionalpoints. First, if you die without awill, the courts will appoint someone toact as personal representative of yourestate. This will likely increase theexpense of administering and settlingyour estate. Second, if you die withouta will, you will have given up the rightto designate who receives your assets.Those distributions will be based onstate law. Your best choice is to workwith competent counsel to set up aproperly drawn will.

Stewart H. Welch III, founder ofthe Welch Group, has been ratedone of the nation's top financialadvisors by Money and Worth. Hewelcomes questions or commentsfrom readers at 800-709-7100 Reprinted with permissionfrom the Birmingham Post Herald.