Whether assets distributed to heirs from an estate are taxable depend on various factors. These factors include whether the state in which the decedent resided imposes an inheritance tax, the amount of inherited assets, and the heir's relationship to the decedent. Contact the estate's attorney or executor to find out if you are liable for taxes on the distribution.
State Inheritance Taxes
Several states impose an inheritance tax on property distributed to the decedent.This is separate from an estate tax, which is imposed on the actual estate and paid before distribution to beneficiaries. Spouses are exempt from paying inheritance taxes. Inheritance tax rates depend on the relationship between the decedent and beneficiary. Lineal descendants, such as children or grandchildren, may be exempt or pay very low rates. Non-lineal descendants, such as nephews, nieces or non-relatives will pay higher rates. States currently imposing an inheritance tax are New Jersey, Pennsylvania, Maryland, Kentucky, Tennessee, Indiana and Iowa.
Paying the Tax
In some situations, inherited property may have to be sold in order to pay the inheritance tax. For example, if you were left a house by a non-lineal relative, such as an aunt who lived in New Jersey, you would owe 16 percent tax on the fair market value of the home. If the house was worth $500,000, you would owe the state $80,000 in inheritance taxes. In many situations, selling inherited real estate is the only way a beneficiary can afford to pay the tax.
Selling Inherited Assets
If you sell inherited assets, your tax basis for the sale is the fair market value of the property at the time of the decedent's death. For example, if a mutual fund was worth $10,000 at the time of death, and had increased to $11,000 by the time you received it as an inheritance, when selling it you would owe capital gains on only $1,000. If it were worth $9,000 when you sold it, you could claim a $1,000 capital loss.
Special Provisions for 2010 Decedents
Beneficiaries inheriting stocks from anyone dying in 2010 faces a different tax situation. For 2010, the Internal Revenue Service considers the cash basis either the fair market value as of the date of death or the actual basis of the decedent. Only large estates are affected by this short-term rule, because no federal estate tax was imposed on any estate if the decedent passed away in 2010. You may see an increase in capital gains taxes if selling stocks inherited by a 2010 decedent.