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Dollars & Sense: Will I Pay Taxes On My Inheritance?

By Roberta L Nestor

Inheritances come in many forms.  It can be anything from a family jewel, to a house or investments.  Regardless of its form, receiving an inheritance can impact your taxes.  In many instances an inheritance can inflate your overall income and potentially affect taxation of social security benefits, Medicare premiums could be adjusted and for those with college students, it can impact eligibility for financial aid.  There is nothing wrong with letting your inheritance sit until you have explored all of your options and have a full understanding of how a windfall can affect your personal taxes.

Do I need to pay taxes on money I inherit that comes from a bank savings or CD?

You do not have to pay taxes on your federal tax return as long as the cash inherited is not from a retirement account.  The IRS does not impose an inheritance tax.  However, there are a handful of states (Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania) that do have some kind of inheritance tax.

Will I need to pay taxes if I inherit a home or real estate?

Inheriting a home is not a taxable event.  Values of the home (or other real estate) are established as of the date of death.  Once you take ownership and subsequently sell the home or property you will pay taxes on any gains.  For example, if you inherited a home valued at death of $250,000, and you sell it a year later for $275,000 you would have to declare this as a long term capital gain and pay taxes on the $25,000 gain.  Your cost-basis is determined when you take ownership.

Are life insurance proceeds taxable to me?

Life insurance proceeds are not taxable or reported as income to the beneficiaries.  However, any interest on the proceeds (such as when the proceeds are delayed) are reportable.  The beneficiaries will receive a Form 1099-INT and that interest is taxable for federal and state tax purposes.  However, if proceeds from a life insurance policy are transferred as part of a financial arrangement before the insured’s death, then they are fully taxed.

What happens if I inherit a 401k or IRA account?

Generally speaking, only the distributions from an inherited traditional IRA are taxable, just as they are for non-inherited traditional IRAs.  Distributions from an inherited Roth are not taxable unless the Roth was established within the past 5 years.

Inherited 401(k) plans are (or eventually will be) taxable but the amount of tax depends on the 401(k) plan rules.  For example, many 401(k) plans require a lump-sum distribution upon the death of the account holder.  The surviving spouse can roll the 401(k) into an IRA, but if the beneficiary is not a spouse, they might be forced to take a lump-sum payment and the tax bill that goes along with it.

When it comes to inherited IRAs and other retirement plans, the rules can get pretty complicated and you should seek tax and financial advice before receiving any distributions.

Will I pay tax if I inherit stocks?

Typically, when you sell a stock or fund, you pay capital gains tax on any gain that has occurred since you bought it.  When you inherit stock, the cost basis is based on the fair market value of the stock or fund at the time of death.

What about inheriting artwork or jewelry?

If you inherit artwork, jewelry or collectibles and you sell them, you will have to pay taxes on the net gain of the sale.  There is a hefty 28% capital gains tax rate, as compared to the 15% to 20% that applies to most capital assets, on the sale of inherited collectibles.  The value is based on the value at the date of death, or the alternate valuation date.  Items in this category include anything that is considered an item worth collecting.  Generally, rare stamps, books, coins, art, fine wine, glassware, antiques, etc., fall under the collectibles umbrella.

As always, consult with a professional before you sign and accept your inheritance.  Chances are you may not be emotionally prepared to make big financial decisions – go slow!

Roberta L. Nestor is a financial advisor practicing at 491 New Haven Avenue, in Milford, CT offering retirement, long term care, investment and tax planning services.  She also offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network – a member FINRA/SIPC and a Registered Investment Adviser.  She can be reached at 203-876-8066 or roberta@nestorfinancial.com.  This material has been provided for general informational purposes only and does not constitute either tax or legal advice.  Investors should consult a tax preparer, professional tax advisor, and/or a lawyer.

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