Tag Archives: capital gain taxes

Taxes and Beneficiaries: Estate, Income and Capital Gains

Dear Liza:

My aunt died recently, leaving her estate to me and my four siblings, in equal shares. She owned stocks and bonds, and some farmland in Iowa. Will I have to pay taxes on my share of the distributions?

That’s such a good question! You are most definitely not alone — almost everyone who receives an inheritance worries about the tax implications of the gift.

There are actually three taxes to consider here:

  1. The estate tax. If your aunt died in 2017, and owned less than $5.49 million dollars (like most people), her estate would owe no estate tax. That tax falls on the estate, not on the beneficiaries, so, even it were due, the trustee would pay that first, then distribute the assets to you and your siblings. The trust might pay it, then distribute what’s left, or, the trust might pay it, then deduct the tax payment from each distribution, but in your aunt’s case, let’s assume zero tax.
  2. Income tax. Beneficiaries don’t have to pay tax on distributions from the trust’s principal, but they will have to pay income tax on distributions from trust income to the extent that there are distributions to the beneficiaries or in the final year of a trust.  Income tax rates are much more compressed for trusts than for individuals, which means that a trust’s income is taxed at a much higher rate than that same income would be taxed to an individual.  That’s why it is usually better to distribute all the trust’s income out to the beneficiaries so that each beneficiary can pay tax on that income at their lower individual rate. How can you know which distributions are from principal and which are from income? Only the taxable portion of the distribution will be reported on the Form K-1 that you will receive from the trustee.
  3. Capital gains taxes. If your aunt’s assets have gone up in value since she died, and you sell what you’ve inherited from her (like stocks for example), you would have to pay capital gains taxes on the gain since the time of her death.

Reducing Capital Gains: Step-up in Basis, The Basics

Dear Liza: My parents a house in 1995. They put the house in a trust in 1998 with me and my 2 brothers as beneficiaries. My dad passed away in 2007 and my mom in 2015. The house is now for sale . I’m not sure what the tax basis should be. That is a really good question, because, as I’m pretty sure you already know, the difference between the basis of the house and the sale price of the house will determine whether or not you and your 2 brothers are going to owe capital gains taxes on the sale of the house.

Just to review: capital gains taxes are due on the difference between an asset’s basis and its sale price. So, for example, if you buy a share of stock for $10/share and you sell that stock for $110/share, you would owe capital gains on that $100 of gain. Where I practice, in California, we estimate capital gains to be about 33% (federal top rate of 23.8%, plus 13.3% California top income tax rate), so you’d owe about $33/share, worse case scenario.

Assets that you inherit at death get what’s called a step-up in basis. If your mother, for example, had bought that same stock at $10/share, but hadn’t sold it during her lifetime, you and your brothers will inherit that stock at what it was worth the day she died. If that was $110/share, and you then sold those shares for $110/share, you’d owe no capital gains taxes at all.

Houses, like stocks, also receive a step-up in basis at death. But I can’t actually tell you what the basis in your mother’s house would be because I don’t know enough of the facts. The answer depends on what kind of living trust they had, and that also can depend on where they lived.

If your mother and father had a living trust that held the entire house in one revocable trust for your mother’s benefit, you and your siblings will inherit that house at its value on your mother’s date of death.  Since you are selling it two years after her death you need an appraisal to document its value on your mother’s date of death.  If you didn’t get one when she died, you can still get one that looks at the value in 2015, it will just cost more to get. That 2015 value will be your basis.

For example, if the house was appraised at $350,000 in 2015, and you are selling it for $450,000, you will have to pay capital gains on that $100,000 of gain.

If your mother and father, however, had what’s called an “A/B” trust, in which your father’s assets were placed in an irrevocable trust for your mother’s benefit (usually called a “Bypass Trust” or a “Credit Trust”), then the portion of the house held in that trust will not receive a second step up in basis at your mother’s death, and you’ll have to pay capital gains on the gain from 2007 until now.

For example, if, when your father died, the house was appraised at $200,000, and, as is common, half of the house was held in the Bypass Trust, and you are selling it now for $450,000, you are going to have to pay more in capital gains than you would if all of the house was in a revocable trust. Here’s how it works:

Half of the house was held in the Bypass Trust and has a basis of $100,000 (because the house was worth $ 200,000 in 2007, when your father died). Upon sale, that half of the house had a basis of $100,000 ($200,000/2) and realized $125,000 of gain ($225,000 – $100,000). The other half of the house, which was in your Mom’s revocable trust, gets a full step up, so has a basis of $175,000 ($350,000/2). That half of the house realized gain of $50,000 ($225,000-$175,000). So, you and your siblings will owe capital gains on $175,000 ($125,000 from your Dad’s trust plus $50,000 from your Mom’s trust).

As you can see, the kind of trust your parents had will greatly affect the capital gains taxes you and your brothers will owe upon sale. So, first step, figure out what kind of trust they had. Next step, consult with an accountant.