How your inheritance will be taxed


Q. As of 2018, New Jersey has eliminated the estate tax. For Class “A” beneficiaries there is no inheritance tax. When Class “A” beneficiaries inherit their parents’ residence and taxable accounts, is the inheritance at the stepped-up value if sold soon after?
— Beneficiary

A. Let’s run through what you need to understand about inheritances.

Generally, the basis of property acquired from a decedent is its fair market value on the date of the decedent’s death, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.

She said this value is usually greater than the decedent’s cost basis, therefore it is referred to as a “stepped-up” basis. It is possible the basis could be lower.

“As a result of the step-up in basis, should you sell the property immediately after death, there is typically no income tax consequence,” she said. “The gain you would report on the sale, in sum, is the sales price less selling expenses less the fair market value of the property at the date of death.”

With respect to investment accounts, the new basis of a security is determined by taking the mean of the high and low price of the security on the date of death, not the close price, Romania said.

“If the decedent passed away over a weekend, the date of death value is determined by taking the average of: (a) the mean of the high and the low value on Friday, and (b) the mean of the high and the low value on Monday,” she said. “The financial institution will generally provide the value for you.”

In estates that are taxable, Romania said, instead of using the date of death, an alternate valuation date – the date six months after the date of death – can be elected. In that case, it must be used to value all of the assets as of such date. You cannot elect date of death value for some assets and alternate value for others, she said.

“Additionally in estates that are taxable, the IRS requires consistency in reporting so the basis utilized by the beneficiary as the value of the property received from the decedent cannot be greater than the value of the property reported on the decedent’s estate tax return,” Romania said.

Retirement accounts other than Roth IRAs require income tax to be paid when distributions are made to the beneficiary – just like it would have had to be paid on distribution to the decedent – she said. The value of the retirement account in the decedent’s estate and/or passing to the beneficiary is not reduced by the income tax that will have to be paid on future distributions, she said.

“In contrast to the fair market value on date of death, when you receive property as a gift, you obtain the donor’s basis in the property,” she said. “Therefore a subsequent sale of property received by gift will likely have a greater income tax impact to you as the recipient than a sale of property that was inherited from a decedent.”

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