Taxes are often the last thing on your mind when it comes to inheritance because you've lost someone you cared about. You aren't required to file a federal tax return just because a decedent bequeathed you property. However, you may need to file a state tax return or have income to report on your income taxes down the road when you sell the inherited property.
State Inheritance Taxes
The Internal Revenue Service only imposes an estate tax rather than an inheritance tax. This means the return is filed and the taxes are paid by the decedent's estate before the money is distributed to you as an heir. However, depending on where the decedent resided and kept property, you might be required to file a state inheritance tax return. Some states also take into consideration your relationship to the decedent. For example, in Iowa, you won't owe a tax if you inherited the property from your parents, but you will owe if you inherited it from a sibling.
Doesn't Count as Income
When you file your next federal income tax return, the IRS won't be expecting to see the inherited property show up as income on your return. For example, getting a $10,000 check from the estate won't boost your income taxes. However, if that property has generated additional income since the decedent died, you have to include that. For example, say you inherited a bank account worth $10,000. If it accrues $200 in interest during the year, you must report that $200 as income.
Selling Inherited Property
When you sell inherited property, that's when your taxes can really start to be impacted because then you have the potential to realize gains or losses. For example, if you inherit shares of a publicly traded company, but just hold them, you won't have any gains or losses. Once you sell them, you must pay taxes on any increase in the value since the decedent's death. For example, if the shares were worth $1,500 when the decedent died, and you sell them three months later for $1,800, you must include $300 of gain on your income taxes.
Capital Gain Tax Rates
A nice perk of inherited property is that any gains on selling it count as long-term capital gains, no matter how long you or the decedent owned it. Usually, you must own property for more than a year before you qualify for the lower rates. The tax savings can be substantial. As of 2014, the maximum ordinary income tax rate is 39.6 percent, but it's only 20 percent for long-term capital gains. In fact, if you're in the 15 percent tax bracket or lower, you won't pay any taxes on your long-term capital gains.
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