As baby boomers continue to get older, within the next 10 to 15 years I think we’re going to see a wealth transfer to that next generation. And as our clients are starting to work through these things, the number-one question that we get from them is, “How is this going to affect my survivors from a tax point of view?”
So let’s start at the beginning. When a person passes away, all of their assets have to be used to pay off whatever debts that they have, but everything after that gets inherited to somebody.
So I heard, though, that if you receive an inheritance you don’t owe any taxes on that, is that correct?
You know, in general that’s right. So things like cash, investment securities, real estate … those kind of things, you’re probably not going to owe any taxes on. But if you get an inheritance that includes IRAs, annuities, retirement accounts … then you will.
Quick question: What about if you inherited a Roth IRA, because that’s after people already payed taxes on that?
Right, that would be tax free also. So that would kind of fit in that first category, you’re right.
So, why is there a difference in the tax treatment?
So in Wisconsin, like a bunch of other states, you get what’s called a “step up in basis.” Now, you get the step up for things like cash, investments, real estate … but you don’t get that step up for IRAs, annuities and retirement accounts.
What is a “step up”? I’ve never heard of that.
So a step up is—no matter what you actually paid for something, whether it’s a house, whether it’s an investment—your new cost basis is the fair market value at your death. And if you immediately sell it, your cost basis compared to the fair market value is the same, so you have no gain, which means you pay no tax.
Now, there are certain states that allow for a double step up, there are certain states that allow just for a half step up … so you just have to look at your state to determine what the step up is.
But income assets like IRAs and things like that—they don’t get that step up, and so that’s why you have to pay income tax on that, because your base is essentially zero and so you pay tax on the difference.
So what about life insurance proceeds; do you have to pay taxes on those policies?
They are tax free—no tax at all.
What about income earned on the asset after you received it?
Sure, that’s another question that people ask about. So, even though if you sold the assets on the day that you receive them, you probably wouldn’t have any gain. If you hold those assets for any period of time, as soon as you have it in your hands—from the date of death to the date that you sell it—that’s going to be income to you (any kind of earnings that happen there).
Now next week we’re going to talk about inherited IRAs, annuities and retirement plans, since that’s changed recently and that’s the taxable part of it.
So knowing the rules on inherited property will help you ask the right questions when you’re talking to a tax professional. So I think it’s really important that you talk to somebody if you’re going to be getting an inheritance.
