Monument Resource Center

Our clients hire us because they recognize the value of our Team’s unique, straight-forward, unfiltered opinion and our tailored advice designed to answer their questions, not everyone else’s. Below, you’ll find some of the most important questions we have been asked over the years to help you better understand the role we play and the advice we give.

Is An Inheritance Taxable? It Depends, and Here’s Why.

Actually receiving an inheritance from someone who has passed away isn’t a taxable event, but how much tax you’ll pay when you take money out of that asset—for example by selling a stock or distributing money from a retirement account—depends on the asset itself. Here’s why.

Got a step-up in basis? You’ll owe less tax if you sell.

When an heir receives an asset from a decedent, the value of the property must be determined. Generally, this new, adjusted value (known as the adjusted basis) for income tax purposes is the property’s current fair market value (FMV) as reported on the decedent’s estate tax return. This can be either the FMV at the decedent’s date of death or the alternate valuation date (six months after the date of death) if that was selected. This new basis is referred to as a step-up in basis for the heir because the heir “steps-up” from the old, lower basis to the new, higher basis.

Basis is important because it determines how much tax you’ll have to pay when you sell.

  • Lower basis = bigger gain = more tax to pay
  • Higher basis = smaller gain = less tax owed

The “holding period” for the property you inherit is always deemed to be a long-term investment (ie. subject to lower long-term capital gains rates). This applies regardless of how long you actually hold the property before selling it.

Example: Gabrielle made a great investment in a stock that grew tremendously during her lifetime. She never sold the stock that she bought at $10/share. When she passed away, Simone inherited the stock, which was worth $150/share. Even though Gabrielle’s basis was $10/share, Simone’s basis will be $150/share (the value at Gabrielle’s death). This means that if she sells the stock when it’s $170/share, she will only pay long-term capital gains tax on a $20/share gain, not a $160/share gain.

When you might not get a step-up in basis.

If you’re inheriting an IRD asset

Assets considered “income in respect of a decedent” (IRD) do not qualify for the step-up in basis adjustment. IRD assets result if the decedent chose during life to defer paying income tax into the future. Common examples of IRD assets are:

  • Qualified retirement plans such as 401k and 403b plans
  • IRAs
  • Annuities
  • Savings bonds
  • Installment notes

As an heir, your basis will be equal to the decedent’s basis in the asset—NOT the value of the asset at the decedent’s death. This ensures that the government will be able to collect income tax due on the deferred income.

Example: Sandra made regular contributions to her IRA and always claimed an income tax deduction. When Sandra dies, her heirs will have a basis in the IRA equal to Sandra’s basis, since the IRA is an IRD asset. When her heirs take distributions from the IRA, they will have to pay ordinary income tax on the distributions.

If you gifted an asset to the decedent within one year of the decedent’s death

If you inherit an asset from the decedent that you in fact had gifted to the decedent within one year of their death, you will not receive a step -up in basis. Your basis will be the decedent’s basis, which will be the same as your original basis before you made the gift.

Example: Blake gives an asset to his father worth $10,000 (less than the annual gift tax exclusion amount, so no gift taxes needed to be paid). Blake’s basis in the property was $2,000, which became Blake’s father’s basis. Blake’s father dies within one year of the gift, and he bequeaths the property back to Blake. Because it’s been less than a year, Blake’s basis in the property is $2,000 (his original basis).

When you receive life insurance proceeds.

If you’re the beneficiary of a life insurance policy on someone who has passed away, as a general rule, the death benefit paid to you will not be subject to income tax.

The only exception is if the decedent owned the policy first and then gave you the policy (ie. made you the owner of the policy) in exchange for “valuable consideration” (ie. you gave the decedent something in exchange for getting the policy or there was an economic reason behind transferring the policy). This is called the “transfer for value” rule.

Note about a possible change to tax law.

The tax code is never set in stone. New administrations and new congressional majorities may seek to make changes to tax law, which is the situation we are in now. While we don’t specifically know what tax laws may change under the Biden administration, we do know that while campaigning for president, Biden suggested:

  • Eliminating step-up in basis for assets at death
  • Death would be a taxable “realization event” (ie. taxes would be owed on capital gains even if heirs don’t sell anything)

This uncertainty can feel unsettling. Luckily, we exist.

A transparent partner for unfiltered advice.

Monument Wealth Management has decades of experience in the financial industry. Navigating and advising on an unpredictable market is what we do for fun. Well… that and helping our dogs live their best lives. We take a no B.S. approach to managing our client’s wealth–keeping you informed of the good, the bad, and the ugly and proposing realistic approaches to each.

Set up an appointment to start your Private Wealth Design. We’ll be your guide to financial freedom no matter what your taxes look like.

*Monument is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. 

IMPORTANT DISCLOSURE INFORMATION

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Monument Capital Management, LLC [“Monument”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Monument.

Please remember that if you are a Monument client, it remains your responsibility to advise Monument, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Monument is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of Monument’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request.

Insurance specific:

The decision to purchase life insurance should be based on long-term financial goals and the need for a death benefit. Life insurance is not an appropriate vehicle for short-term savings or short-term investment strategies. Generally, early surrender charges may apply during the life of the policy. Those charges may decrease the value of the policy substantially depending on how early the policy, or any portion of it, is surrendered or accessed. While a policy allows for access to the account value in the short-term, through loans and withdrawals, there are costs and risks associated with those transactions. There may be little to no account value available for loans and withdrawals.

Estate taxes may apply to insurance proceeds. Consult a financial or tax advisor about your specific financial situation.

Insurance Products are made available by unaffiliated third-party licensed insurance companies. A contract’s financial guarantees are subject to the claims-paying ability of the issuing insurance company.

Variable/Universal Life:

Variable life insurance is a complex vehicle that is subject to market risk, including the potential loss of principal invested. You should consider the investment objectives, risks, charges and expenses of the variable insurance and its underlying investment options carefully before investing. You should review the product prospectus carefully before you invest. Variable universal life insurance is permanent life insurance that offers protection and an opportunity to build cash values. You will incur mortality and expense fees and subaccount expenses and you may also incur optional rider expenses, surrender charges, and policy charges. Please Also Note: IF you are a Monument client, please advise us if you have not been receiving account statements (at least quarterly) from the account custodian.

Please Note: Monument does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Monument’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.