The act of receiving an inherited asset, whether it is real estate, investments or cash, generally does not trigger income tax. However, any subsequent earnings on that asset might be taxable. For example, interest or dividends payments might be subject to income tax. If an heir sells an inherited real estate asset, that sale could also implicate capital gains taxes.
In the real estate example, how is that tax calculated? The basis, or original value, is typically deemed to be the fair market value of the asset at the time of the decedent’s death. The difference between the sale price and the basis could be considered income or gain, subject to tax. The higher the basis, the less potential gain. For 2015, capital gains tax is around 15 percent for assets held over 12 months.
As a tax-saving strategy, is there a way to remove the value of an asset from the total estate’s value? The answer may depend upon the type of asset. One strategy regarding an insurance policy might be an irrevocable life insurance trust. By transferring ownership to the trust, any death benefits generally are not included in the estate. In addition, the trust could also be designated as the policy beneficiary. That way, proceeds will be kept in the trust, but periodic distributions can be made to children, a surviving spouse or other loved ones.
Notably, a house can also be placed in a trust. Called a qualified personal residence trust, this type of transfer can be made during the homeowner’s lifetime. Even after the trust becomes the owner, an individual can continue to live in the property, usually up to 15 years after the transfer. After that period, the home usually transfers to the named trust beneficiaries. An individual may have to pay rent to those beneficiaries if he or she wants to stay in the home after that 15-year period, however.
Source: Consumer Reports, “6 costly estate-planning minefields, and how to avoid them,” April 14, 2015