As estate planning attorneys, we hear a lot of questions about how taxes can impact inheritances. It is natural to brace yourself for some heavy taxation when you are going to receive a significant windfall. Surprisingly, the landscape is quite favorable. With this in mind, we will look at capital gains taxes in this post.
Appreciated Inherited Assets
The best way to explain the way that the IRS treats appreciation that is handed down is through the use of a simple example. Let’s say that you inherit stock from your aunt that is valued at $250,000 when you receive the inheritance.
Your aunt died when she was 90 years old, and she bought the stock decades before her passing. She purchased the stock for just $25,000, so she did very well. If she would have sold the stock during her life, the $225,000 realized gain would be taxable.
Since she had the stock for many years, it would be a long-term gain. The rate depends on your income level. Single filers that make up to $41,675 in 2022 are completely exempt.
Those that claim more than this much but less than $459,751 are in the 15 percent long-term capital gains bracket. Anyone that claims more than this amount will be taxed at a rate of 20 percent for long-term gains.
We will say that you are in the 15 percent group ordinarily, but you would not pay a dime on your inheritance. The assets would get a stepped-up basis, so the gains that accumulated during your aunt’s life would essentially be forgotten. You would only be responsible for future gains that push the value of the stock over $250,000 if and when you realize a gain.
Taxation Overview
While we are on the subject, we will briefly share the other relevant tax information that people have questions about. An inheritance is not looked upon as taxable income on the state or the federal level.
There is one exception to this rule. If you are the beneficiary of a trust, distributions of the principal are not subject to taxation. However, if you accept distributions of the trust’s earnings, they would be taxable.
The beneficiary of an inherited traditional individual retirement account (IRA) will pay taxes on the distributions. This is because the original account holder funded the account with pretax earnings. Roth accounts are funded after taxes have been paid, so beneficiaries are off the hook.
We have a federal estate tax in the United States that carries a 40 percent maximum rate. That’s the bad news, but the good news is that you probably do not have to be concerned about it. The exclusion is $12.06 million, so this tax is not a factor unless your estate’s value exceeds this amount, but this exclusion amount will be significantly reduced on January 1, 2026.
There are 12 states with state-level estate taxes, but California is not one of them. However, if you own property in a state with an estate tax, it will apply to your estate if the property’s value exceeded the exclusion in that state. There is an estate tax in Oregon with a $1 million collision, and there is a Hawaii estate tax with a $5.49 million exclusion.
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If you have learned enough to know that you should work with a Burbank, CA estate planning lawyer to develop a plan, we are ready to help. You can send us a message to request a consultation appointment, and we can be reached by phone at 818-937-2335.
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