Whenever someone passes away, their assets are distributed in accordance with their wishes to beneficiaries. Thanks to tax code regulations, significant amounts of assets are exempt from estate taxes. Currently, most estates valued at $11,580,000 or less will not be subject to federal taxes. Most of the inheritances received are totally tax-free. However, that doesn’t mean that you will never need to pay taxes on what you inherit. What does this look like in practice?
Understanding Inheritance Taxes
Once a beneficiary takes possession of an inherited asset, the income generated from the property can be subject to taxes in the same way it would be if it always belonged to the beneficiary. Whether the income is interest from cash, dividends from stocks, profits from a sale or rent from real estate, it should be considered taxable. When measuring losses or gains, the value of the assets on the date of death should be considered the starting value of the asset.
For example, if Mary inherits her family home, the fair market value of the home on the date of her mother’s passing will be considered the starting price. In order to get that fair market value figure, the home will need to be appraised by a certified appraiser within a reasonable time after the death of her mother. If she decides to sell the home, the value given by the appraiser can be used as FMV when filing taxes. If she failed to get an appraiser to examine the home, the IRS could challenge the amount that she claimed as the fair market value.
There Are Exceptions
In some cases, there are exceptions to the fair market value rule. If any of the assets that the deceased held were untaxed income, they will be treated differently. Some of these untaxed assets can include:
- Traditional IRAs: A spouse beneficiary can typically spread the income over their lifetime. Non-spouse beneficiaries have a 10-year distribution period they must follow. These are taxable when distributed.
- Roth IRAs: Qualified distributions are considered non-taxable.
- Compensation: Any compensation received after death for personal services is considered taxable.
- Pension Payments: Like compensation, these are almost always taxable to the beneficiary.
- Installment Sales: If the decedent had an installment sale set up, anyone who receives the installment amounts after death will be taxed in the same way that the decedent would have been.
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