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Planning Points – Inherited Assets

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With new higher limits for Estate taxes, and in many cases State inheritance taxes, people are often advised that they will incur no taxes as a result of inheriting investments or other assets from a family member or friend.  Further they often take false comfort in the assumption that they do not need to do anything because everything has been handled by the estate.  All they need to do is grieve the lost loved one and incorporate the inherited items into their portfolio, personal property or other listing of assets owned.

This is not only an incorrect assumption, it could result in a costly unexpected income tax liability down the road.  To be fair, this tax concern does not relate to all items you might inherit.  For example, Grandpa’s tool box or Aunt Betty’s bedroom furniture would generally not cause an income tax liability when sold.  The inherited items that can be taxable are business interests, investments, real estate and even certain collectables.

Often, the items inherited are held for many years (in this case time can be our biggest enemy) and sold in connection with some sort of life event.  It may be college, a wedding or maybe even in connection with retirement planning.  In the year sold, these inherited assets may result in the need to report the sale on your income tax return.

Reporting the sale is not the tricky part.  Paying the correct tax based on the correct taxable “gain” on the sale is.  You see, it is true that you have to report the gross sale amount, but that is not necessarily your gain.  In fact, it usually is not the appropriate gain.  You are allowed to deduct your cost basis from the sale price in order to determine the correct taxable amount.  And consequently calculate the appropriate amount of income tax due from the transaction.

But what is your “cost basis”?  Well, in simple terms it is what you paid for the asset.  If it was inherited, you may think you paid nothing.  And in a way that may be true.  But there is good news.  You may have a cost basis after all.

Actions to Consider

At a minimum, your loved one likely bought the asset.  If there is some way for you to document what they paid for it, that amount could be claimed as your basis.  This may be known by other family members or be found in various papers of the deceased.  Papers that will likely disappear within a short time after their death.  Seeking this information immediately can greatly increase your likelihood of obtaining the answers you will need later.

Even better than the initial cost information described above, you may benefit from a “Step-up in Basis” as of the date that your friend or loved one died.  This means that your cost basis will be considered to be the fair value of the asset on the day the benefactor died.  This is most often substantially higher than what your benefactor paid for the items and consequently can greatly decrease the eventual income tax liability that results when you sell it.

Both of the above paths to establish a cost basis are time critical.  With the passage of time, people forget, records are lost, or you just can’t even remember when you got the items or possibly from whom.  Be sure to document an inherited cost basis within months of an inheritance.  It could save you tax dollars later.

If you inherit assets, or have in the past couple years, you may want to consider consulting with a CPA, attorney or other tax professional to discuss what should be done now to protect your wealth later.

Learn how we can help you plan for your financial future by contacting us today.

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