17 Jan How can my kids inherit my property and avoid taxes?
Q. I own my home. In the event of my passing, I will leave my children my home. What’s the best way to do that and reduce the amount of taxes to be assessed on the inherited property as well as 401(k) and IRA accounts?
— Planning ahead
A. It’s good that you’re planning ahead, and depending on your asset level, taxes may not be an issue for your heirs.
There are two types of taxes to consider on death: income taxes and so-called death taxes, which include estate and inheritance taxes, said Catherine Romania, an estate planning attorney with Witman Stadtmauer in Florham Park.
She said New Jersey no longer has an estate tax, and because you are leaving property to your children, no one will incur a New Jersey inheritance tax.
Unless you’re very wealthy, you won’t have to worry about the federal estate tax, either, Romania said.
The federal estate and gift tax exemption amount is now $11.580 million per person, though it’s scheduled to be reduced to $5 million, adjusted for inflation, after Dec. 31, 2026, she said.
With all that, your focus is likely on income taxes.
Let’s start with your home.
“Your home will obtain a step-up in basis upon your death, which means the basis to your children will be equal its value on your date of death,” Romania said. “Thus, if your children inherit the property and list it for sale, they will only incur little if any gain — the difference between the selling price and the value at the date of death less selling expenses — and thus pay little if any income tax.”
Retirement accounts do not receive a step-up in basis upon your death.
If you have a Roth account, you have already paid income tax on the funds you contributed so withdrawals by you or by your beneficiaries are income tax free, with the exception of certain early withdrawal taxes and penalties, she said.
But you have not paid tax — at least at the federal level — on the contributions to your traditional 401(k) and IRA accounts or on the growth and appreciation on the accounts, she said.
“Each time a distribution is made from a traditional retirement account you or your beneficiary will be taxed both on a portion consisting of the original contribution and the portion consisting of the growth/appreciation, Romania said.
With the enactment of the SECURE Act on Dec. 20, 2019, the rules regarding the ability to stretch the payout of inherited retirement accounts over the lifetime of the beneficiary have been drastically reduced.
“In situations with adult children, all distributions from the retirement accounts will generally have to be taken within 10 years of death,” she said. “These distributions will not have to be taken ratably over the 10 years and therefore can be taken in the first or last year or a little in each year based on the child’s income and tax circumstances after discussions with his or her tax and financial advisors.”
The SECURE Act has exceptions to the 10-year payout including for minor children and disabled or chronically ill beneficiaries. Additionally, spouses will still be able to benefit from rolling over a deceased spouse’s retirement account as well as making other elections, Romania said.
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This story was originally published on Jan. 17, 2020.
NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.