Perhaps you have heard the story of Wellington R. Burt, a man who was at one time among the eight wealthiest Americans. Under the terms of his will, the bulk of his estate would not be distributed until 21 years after the death of his last surviving grandchild. Now, 92 years after his death, 12 of his distant heirs will share his estate valued at around $110 million.
Not all inheritances are quite so large or quite so unexpected. Nonetheless, the prospect of an inheritance, whether expected or not, can cause us to dream of newly-available opportunities, such as: new trucks, new homes, new equipment, and tropical family vacations. However, the reality of inheriting money or property often differs from our dreams.
Here are some important factors to consider:
- What are the tax implications? Generally speaking, an inheritance – like a gift – does not come with an income tax burden. This is not always true, however. Certain property, such as IRAs, will require the beneficiary to pay income taxes. Inheritances generally receive favorable capital gains tax treatment as well. Even highly-appreciated property will likely have a small capital gains tax liability depending on when it is sold. Capital gains tax is a tax on the amount an asset has appreciated in value since originally purchased (the original purchase price is known as the “basis” in the property). Inherited items receive a step-up in basis, meaning its value to the beneficiary is its fair market value at the time of the original owner’s death. Rather than being taxed on the difference between the selling price and the price when originally purchased, the tax liability will be based on the difference between the selling price and the value of the property when it was inherited.
- Should I disclaim it? While it may seem counterintuitive, there are times when it may be beneficial to “disclaim” an inheritance. To “disclaim” is the legal term for refusing a gift left to an individual by someone who has passed away. Most often, individuals will disclaim an inheritance for financial reasons, particularly due to current liabilities they are facing or if they already have substantial assets and do not want to add to their taxable estate. When an inheritance is disclaimed, the gift passes as though the disclaiming individual has died prior to inheriting. An individual considering whether to disclaim should talk to a qualified estate planning attorney prior to taking any action. Even small actions, such as accepting an inheritance check, can preclude one’s ability to make a disclaimer.
- What is the timeline for receiving the inheritance? Settling an estate can be a lengthy process and can depend on a number of factors including the law firm that is hired to assist the personal representative or trustee. Assets of the estate must be inventoried, debts paid, estate taxes paid (if any are owed), and under certain circumstances, a probate completed by the court before beneficiaries receive their inheritance. If estate taxes are due, the process may take even longer. The personal representative or trustee of the estate has nine months to complete an estate tax return, unless he or she files for an extension. The Internal Revenue Service typically issues a closing letter within six months of filing, which informs the trustee that the correct amount of tax has been paid and no estate audit will be completed. The trustee is then free to distribute the assets. If the trustee distributes the assets prior to receiving the closing letter, he or she is personally responsible for any shortfall on taxes.
- How does this inheritance affect my own estate plan? A qualified estate planning attorney can help determine if any changes to a current plan are needed, how the newly-inherited assets should be titled, or if other techniques exist to maximize the benefit of the inheritance.
Inheriting assets can be a wonderful gift, but it should be one that is thoughtfully received. Prior to receiving the gift, one should check with an estate planning attorney to make they make the most of the generous legacy being passed on.