Inherited Assets vs. Gifts

When someone gives you cash or other valuable assets, do you owe income tax? No. The same is true if you receive an inheritance. The giver may owe gift tax and the decedent’s estate may owe estate tax but you, as the recipient, won’t owe income tax.

           
 The situation will change, however, if you receive a non-cash asset as a gift or inheritance and subsequently sell that asset. You’ll incur tax consequences, which will depend on your so-called “basis” in the asset. In this context, your basis can be considered your cost for tax purposes.

Carryover basis

When you receive an appreciated asset as a gift, you also receive the giver’s basis in that gift. In tax parlance, the former owner’s basis “carries over” to you.

            
Example 1: Mike Owens invested $10,000 in ABC Corp. stock many years ago. Mike always receives the dividends from ABC, rather than reinvesting them. When the shares are worth $19,000, Mike gives those shares to his niece Pam. In this scenario, Pam retains Mike’s $10,000 basis in the shares. If she sells the shares for $22,000, Pam will owe tax on a $12,000 gain, because of the carryover basis, rather than owing tax on the $3,000 gain since the gift.

            
For gifts of appreciated assets, the donor’s holding period also carries over. Here, Pam will have a favorably taxed long-term gain because Mike held the shares for many years. In another situation, where Pam’s sale takes place one year or less since Mike’s purchase, her $12,000 gain would be taxed at higher ordinary income rates.

(The carryover basis rules on gifts of depreciated property are more complex. If you have received such a gift, our office can explain the tax consequences of a future sale.)

Stepped-up basis

Different rules apply to inherited assets. Here, the heir’s basis typically is the asset’s value on the date of death.
Example 2: Rebecca Smith dies and leaves $200,000 worth of XYZ Corp. shares to her nephew Tom. Even if Rebecca’s basis in the shares was only, say, $90,000, Tom’s basis in the shares is $200,000, their value when Rebecca died. Tom will have no taxable gain on a subsequent sale for $200,000, a $10,000 gain on a sale for $210,000, and a $5,000 capital loss on a sale for $195,000. Depreciated assets are stepped down: if Rebecca had bought the shares for $200,000, but they were worth $90,000 when she died, Tom’s basis would be $90,000.
After an inheritance, sales generally are taxed as a long-term gain or loss, regardless of the heir’s or the decedent’s holding period.
In some cases, special rules apply to the basis of inherited assets. For property held jointly with right of survivorship (JTWROS), the survivor generally gets a basis step up for half of the asset value.

Example 3: Victor and Wendy Young hold shares of DEF Corp. in a brokerage account. The account is titled as JTWROS, so the surviving co-owner will be the sole owner. Victor dies first, when the couple’s basis in the shares is $60,000 and the current value is $88,000.       

Going forward, Wendy owns those DEF shares. Her basis is stepped up to $74,000: $30,000 for her half of the previous $60,000 basis plus $44,000 for Victor’s half of the current $88,000 value, which is stepped up at his death. If Wendy sells the DEF shares a week later for $89,000, she will have a $15,000 long-term capital gain, considering the basis increase to $74,000 at Victor’s death. (Different rules may apply to property held by married couples living in community property states.)

Basis backup

As you can see, documenting your basis in gifted or inherited assets is vital. When you get a gift, find out the giver’s basis in that asset; after an inheritance, document the date of death value (or the value on the alternative valuation date, as explained in the “Second Look” Trusted Advice column herein).
 Putting a value on listed securities or other assets held in an investment account may be relatively easy. Such information should be available online or from the financial firm holding the assets. If you receive a gift of stock from Uncle Joe, who dimly recalls buying the shares “in the 1980s,” make every effort to find a number that can be justified by hard evidence.

Liquid assets present more of a challenge. Again, try to get a valuation you can support for the basis of assets you receive as a gift. For inherited assets, hire a reputable professional as soon as possible to appraise assets, such as real estate, collectibles and shares of a closely held company.

 Second Look

·       The basis of inherited assets may be affected by the so-called “alternative valuation date.”

·       An estate’s executor can choose to have all the estate assets valued as of six months after death, rather than the date of death, if that will reduce estate tax or the generation-skipping transfer tax.

·       In that case, the valuation six months after death will be the basis of all inherited assets, on future sales by the heirs.

---