How Inherited Assets Differ From Gifts

We all love getting gifts. But sometimes, receiving a gift today may cost you later in capital gains taxes. So, when it comes time to passing your assets to your children and other loved ones, you should understand the pros and cons of lifetime gifts versus an inheritance. Consulting with an estate planning attorney in New York helps to make the most beneficial decisions.

When you receive cash or other valuable assets as a gift, you do not owe income tax on those assets. This is true regardless of whether the gift is given during the donor’s lifetime or if it’s received as an inheritance. For example, the donor may owe a gift tax, and the estate may owe an estate tax, but the recipient does not owe tax upon receipt.

This is great news. Now comes the not-so-great news. If you receive a non-cash asset as a gift or inheritance and subsequently sell that asset, you will incur tax consequences. The extent of your tax consequences depends on your “basis” in the asset.

Carryover and Stepped-up Basis

Basis is essentially the original cost of property, adjusted for various factors like depreciation, capital improvements, stock splits, dividends, and return of capital distributions. There are two main types of basis that relate to gifts given during life and gifts received as an inheritance:

Carryover Basis

When you receive an appreciated asset as a gift, you also receive the giver’s basis in that gift. This means the previous owner’s basis “carries over” to you.

For example, let’s look at Joe’s situation. Joe invested $10,000 in ABC Corp. stock many years ago. Joe always received dividends from ABC rather than reinvesting them. When the shares are worth $19,000, Joe gives those shares to his nephew Sam. In this scenario, Sam retains Joe’s $10,000 basis in the shares. If he sells the shares for $22,000, Sam will owe tax on the $12,000 gain instead of owing tax on the $3,000 gain since the gift.

The donor’s holding period also carries over for gifts of appreciated assets. Here, Sam will have a favorably taxed long-term gain because Joe held the shares for many years. In another situation, where Sam’s sale takes place one year or less after Joe’s purchase, her $12,000 gain would be taxed at higher ordinary income rates. This is considered a short-term gain.

Stepped-up Basis

Different rules apply to inherited assets. Here, the heir’s basis typically is the asset’s value on the owner’s date of death.

For example, Robert Smith dies and leaves $200,000 worth of XYZ Corp. shares to his niece Maggie. Even if Robert’s basis in the shares was only $90,000, Maggie’s basis in the shares is $200,000, which was the value when Robert died. Maggie will have no taxable gain on a subsequent sale for $200,000, a $10,000 gain on a sale for $210,000, and a $5,000 capital loss on a sale for $195,000.

Depreciated assets are stepped down. For instance, if Robert had bought the shares for $200,000, but they were worth $90,000 when he died, Maggie’s basis would be $90,000. After an inheritance, sales are generally taxed as a long-term gain or loss, regardless of the holding period.

Estate Planning Professionals

It is important to speak with a qualified estate planning attorney in New York if you are considering gifting assets or leaving an inheritance to a loved one. Also, seek guidance if you have received an inheritance or gift to understand how it will affect your estate plan and estate taxes.

Please do not hesitate to contact Russo Law Group, P.C, with questions. Benefit from our experience, as well as caring and compassionate staff. You may also take advantage of our free seminars and webinars to learn more about how Russo Law Group, P.C., helps with guardianship proceedings.