Are you inheriting assets? Read This.
A helpful guide for inherited asset transfers and taxation.
Recently I’ve had several new clients and existing clients who have had parents or other family members pass away and have received inheritances as a result.
While this is usually a sad time for them, my clients are fortunate to receive significant financial assets which bolster their personal financial positions.
Despite benefiting from the inheritance, it's a stressful transition period for my clients due to the complexity of inheritance.
I’ve decided to write a short guide to help anyone who is experiencing an inheritance right now or who might in the future.
Inheriting assets can significantly impact your financial landscape, offering both opportunities and responsibilities.
The two most common asset types inherited are real estate and investment accounts, each carrying unique valuation methods, tax implications, and transfer procedures.
Understanding these essentials can simplify the inheritance process and inform wise financial planning.
Real Estate
(including mineral rights)
Valuation:
Inherited real estate typically receives a "step-up" in basis. This means the property's new cost basis becomes its fair market value at the original owner's date of death.
An appraisal is usually conducted by a qualified professional to determine the precise market value.
Taxation:
Capital Gains Tax: Beneficiaries only owe capital gains taxes on the appreciation from the stepped-up basis if they sell the property later. Capital gains are only reported on your tax return. An appraisal will give you a date and value you can use on your tax return and in any possible audit defense.
Estate Taxes: Properties included in an estate exceeding the federal exemption amount (currently $12.92 million per individual in 2024) could be subject to estate taxes.
Steps to Transfer Ownership:
Obtain a certified copy of the original owner's death certificate.
File the will (if applicable) through probate court to establish legal rights to the property.
Conduct a property appraisal to establish a stepped-up basis.
Transfer the title through probate or via a transfer-on-death (TOD) deed, depending on the estate planning. I recommend using an attorney to ensure the transfer is completed accurately and legally.
Investment Accounts
Investment accounts like IRAs, 401(k)s, brokerage accounts, and mutual funds are frequently inherited.
Valuation:
Investment accounts also benefit from the stepped-up basis upon inheritance, except for qualified retirement accounts (IRAs, 401(k)s), which do not receive a stepped-up basis.
Taxation:
Non-Retirement Brokerage Accounts: These accounts are commonly referred to as individual accounts. Beneficiaries receive a stepped-up basis, and capital gains taxes apply only on gains from this new basis if sold later.
Traditional IRAs and 401(k)s: Withdrawals are taxed as ordinary income. Beneficiaries generally have 10 years to withdraw all funds unless they qualify as an eligible designated beneficiary (see below). I recommend coordinating the withdrawals with your own retirement plan to reduce taxation as much as possible.
Roth IRAs: Withdrawals are typically tax-free if the original account was held for five years. Just like with Traditional IRAs, Roth IRAs must be emptied by the end of the 10th year after inheriting it although there is no tax on the withdrawal.
Here is a list of eligible designated beneficiaries:
Spouse: The surviving spouse of the account owner.
Minor Children: A minor child of the account owner (under age 21).
Disabled Individuals: Those who meet the IRS definition of disabled.
Chronically Ill Individuals: Those who meet the IRS definition of chronically ill.
Individuals Not More Than 10 Years Younger: An individual not more than 10 years younger than the account owner.
Defined Benefit Plans: Certain defined benefit plans may allow beneficiaries to be treated as EDBs based on prior definitions of "age of majority".
Steps to Transfer Ownership:
Obtain a death certificate for the deceased account holder.
Notify the financial institution managing the account.
Provide documentation (such as death certificate, probate letters, beneficiary designation forms).
Open your correct account to transfer funds according to IRS rules.
For inherited, non-retirement accounts you can open an individual account.
For retirement accounts like IRAs, you must transfer it into a Beneficiary IRA.
Practical Tips for Beneficiaries:
Engage with financial advisors and tax professionals early to navigate tax implications effectively.
Keep meticulous records, especially valuation documents, for future tax purposes.
When requesting death certificates, I recommend paying for 5-10 copies depending on the number of assets and bank accounts. Most companies will want an original copy submitted with a claim form and processing times vary. Having multiple copies ensures fast processing.
Consider long-term financial planning, including how inherited assets align with your financial goals.
Understanding the nuances of inheritance regarding real estate and investment accounts equips beneficiaries to manage and integrate these assets strategically into their financial plans, minimizing surprises and maximizing financial stability.