- Generally, there is no income tax imposed upon assets beneficiaries inherit.
- However, when they later sell inherited assets, (i.e., appreciated securities and real estate), they will most likely owe income tax on the capital gains.
- Income taxes are an important factor when deciding whether you should gift assets now or transfer them to heirs upon your death.
Capital Gains Taxes: How Are They Classified?
Capital gains and losses are classified as either short term or long term. The distinction depends on how long you own the asset. A holding period of one year or less is short term; more than one year is long term. Inherited property is considered long term regardless of how long you own it. Short-term capital gains are taxed as ordinary income, whereas long-term gains are taxed at rates ranging from 0% to 20%, depending on your gross taxable income. (But watch out for Biden’s tax plan and proposed tax on capital gains).
Taxable Income Thresholds for Long-Term Capital Gains
| Tax rate | Single filers | Married joint filers |
| 0% | Up to $40,400 | Up to $80,800 |
| 15% | $40,401 to $445,850 | $80,801 to $501,600 |
| 20% | More than $445,850 | More than $501,600 |
The basis of an asset is generally equal to the purchase price paid for it plus associated expenses (such as taxes and commissions on the transaction). Basis in real property may be adjusted upward for the cost of capital improvements or downward for depreciation taken for tax purposes and insurance reimbursements for casualty losses or theft.
When you gift highly appreciated assets, keep in mind that your basis will carry over with the gift. Here’s an example. You bought shares of stock for $50,000 (your basis) 20 years ago and they are now worth $150,000. You would realize a capital gain of about $100,000 if you were to sell the shares today.
If you gift those shares during your lifetime, they keep the $50,000 basis. When your beneficiary of the gift sells the shares, they can face substantial capital gains taxes — for the gains during your lifetime plus any additional gains that occur after they receive the gift.
However, if you leave assets to your children in your estate upon your death, their basis will step up to their fair market value at the time of your death. Your heirs will be liable only for the taxes due upon any gain in value above their stepped-up basis, effectively erasing all capital gains that occurred during your lifetime.
Gift Tax and Other Factors
In addition to the potential for a stepped-up basis on inherited assets, you might consider the following when deciding whether to gift highly appreciated assets to your children or other family members.
Does the recipient need the gift now, or can it wait? Could you gift cash or other property that would not trigger capital gains tax instead?
What tax rate might apply to capital gains on the sale of the asset? This is very important because if a beneficiary’s taxable income rate is 0%, there probably is no benefit to waiting until death to achieve a step-up in basis. On the other hand, if the beneficiary is subject to a high income tax rate, you could gift the asset or sell it yourself and gift the cash proceeds.
If you are looking for additional details on this topic or if you require advice about your situation, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at fniemann@hnlawfirm.com. Please ask us about our video conferencing or telephone consultations if you are unable to come to our office.
By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Estate Planning Attorney