Do I Owe Taxes on an Inheritance or Gift?

People receive assets from their loved ones all the time in the form of an outright gift or an inheritance under a will. Many individuals question whether there is a tax on the gift or inheritance, and the simple answer is no (unless you live in Maryland or New Jersey). 

But what happens when the asset you received is sold by you? It is important to understand your cost basis in the transferred asset. How the asset is passed to you determines the cost basis you will take in the asset for tax purposes.

Cost basis is the value that is assigned to the asset when it changes hands. Knowing the cost basis is important for the purposes of calculating your gain or loss when you eventually decide to sell the asset. The gain or loss resulting from the sale of the asset has to be reported on your income tax return. The gain or loss is equal to the difference between the cost basis and selling price of the asset.

When an individual gifts an asset to you during their lifetime, it is an outright gift, and your cost basis in the asset is equal to the giver’s (the individual giving the gift) cost basis. In other words, your cost basis is the amount the giver paid for the asset* when the giver bought it or acquired it. If the asset has appreciated in value before it was gifted to you, there is no recognition of any gain when the asset changes hand. Gain will be recognized and taxable upon the sale or other disposition of the appreciated asset.

For example, if A has stock that he bought for $100 in 2010 and gives it to his daughter B in 2017 when it is worth $200, B’s cost basis in the stock for tax purposes is $100. Since she received this as a gift she takes her father’s basis in the stock. She is not taxed on the appreciation in value when the stock changes hands. Years later when she sells it and the fair market value of the stock is $250, her capital gain will be $250 - $100 = $150. B will be taxed on capital gain of $150 when she sells the stock.

Alternatively, if you receive the asset as an inheritance, you receive a cost basis in the asset equal to the fair market value of the asset on the date of the person’s death. Thus, you will receive what is called a stepped-up basis or increased cost basis in the asset.

For example, C has stock that he bought for $100 in 2010 and leaves it to his daughter D in his will. C dies in 2017 when the stock is worth $200 and D inherits the stock. D’s cost basis in the stock for tax purposes is $200, the fair market value at the date of death. This is what we call a stepped-up basis because the cost basis increased from $100 to $200. Again D is not taxed on the appreciation in value when the stock changes hands. Years later when D sells it and the fair market value of the stock is $250, her capital gain will be $250 - $200 = $50. D will only be taxed on capital gain of $50 when she sells the stock.

In sum, in the case of inheritances you need to know the value at the date-of-death and in the case of gifts you need to know the giver’s cost or what the giver paid for the asset. Thus, although you may not be taxed on the receipt of an inheritance or gift, it is important to learn about the cost-basis in the asset so that when you eventually sell it, you will know how to properly report the sale for tax purposes and pay the appropriate tax. If you have any questions about tax and estate planning, please feel free to contact Glick and Trostin, LLC at 312-346-8258.

*The giver may also have acquired the asset by gift or inheritance which would establish the basis. Cost basis may also be adjusted by other factors, such as depreciation, improvement, etc.

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