Receiving an inheritance is one of the few silver linings when the unfortunate loss of a loved one strikes—and knowing the tax laws involved can help make sure you get everything your loved one wanted you to receive.
Whether you are entering probate from an inheritance or just getting started with the entire inheritance process, there are most definitely steps to take in order to ensure all legal i’s are dotted and t’s are crossed.
The taxes can make all the difference. If it costs so much to keep the taxes paid, is it really something you want?
There are some things you need to know before you make a decision like that. Understanding what will be taxed and what some of your financial risks are can help you plan for a great future no matter what inheritance comes your way. Brush up and get familiar on how to avoid capital gains tax on inherited property, you’ll be glad you took the extra time.
What taxes can you expect to pay?
The good news is that inheritances don’t count as income for federal taxes. It’s what happens after you receive an inheritance that can cause some trouble.
For example, if you receive dividends from inherited investments, that money is taxable. So is interest on money in an inherited bank account.
More about inherited investments
If your inherited mutual funds or stocks aren’t already rolled into an IRA or 401K, they can be valued at the time of death or by an alternate valuation date. The alternate valuation date is six months after the death date.
Once you know the valuation, you can figure out whether you’ll have a loss if you sell it or a capital gain. If you have capital gains, you’ll have to pay taxes on the amount that the value grew between the time you received it and the time you sold it.
Check out the retirement account
This is another area where the amount of money initially inherited isn’t taxed. However, if you draw money out of it, the amount you draw out becomes taxable income for you.
Some people roll the money over into an inherited IRA account, which allows you to get minimum distributions rather than getting the money all at once. The amount you’ll need to legally draw out is dependent on your age and life expectancy.
What about taxes on life insurance money?
We’re happy to say there usually aren’t any. Life insurance money isn’t counted as taxable income on a federal tax form.
What can you do to manage inheritance-related financial woes?
First of all, avoid the common mistakes—mostly meaning, don’t rush into anything.
Talk to a financial planner
You may be pressured to buy investments or otherwise spend the money you’ve inherited. Instead of acting rashly on what looks like a good deal, talk to a financial planner who is focused on the planning aspect. A good financial planner will steer you away from purchasing risky investments or insurance.
Likewise, don’t get talked into paying debts for the deceased. All debts should be paid off and should come out of the estate when the estate is settled—not out of your pocket.
Talk to a tax specialist
Make sure you understand how your inheritance will be taxed. Since tax laws vary from state to state, a local tax specialist can help you determine whether you’ll have to pay state taxes based on your inheritance as well as federal ones.
Set up a trust
One of the best ways to limit the taxes you’ll pay is to have a trust set up. A trust acts like a will but allows the estate to pass by probate. This cuts back on costs.
Take your time deciding about the house
If you haven’t lived in the house where the deceased lived, you’ll want to get to know it before you make any decisions. Are there repairs that need to be made? Is it still under a mortgage that you’ll need to pay? What are the property taxes like? How is the house insured?
Often real estate property is inherited by more than one family member, too. As you work through these issues, remember to slow down and take your time so you can make the best possible choices.