Inheritance Vs. Estate Taxes

• The general rule of thumb for heirs is that the estate pays taxes on what it distributes, and heirs don't pay any taxes. Notable exceptions include inheriting an IRA or 401(k) as a beneficiary. Those distributions are taxed at your current income tax rate. (Special rules apply if you are the deceased's spouse.) If you inherit property such as a house, car or other valuable item, it passes to you without penalty--at least initially. If you decide to sell the property, you must figure out its basis and report the gain on your income taxes.
  
  

Calculating the Basis

• Calculating the gain on inherited property requires knowing what the property was worth on the date the person died. For example, if Aunt Mildred's clock collection had a fair market value of $10,000 when she died, and it now has a fair market value of $13,000, your gain is $3,000. Fair market value is defined as the price that is agreed to by a willing and knowledgable buyer and seller--not a distress sale or a situation where the seller doesn't know or understand what the property is worth. If you're unsure what the market value would have been at the time of death, consider consulting an appraiser who is knowledgable about the property. You can deduct the cost of the appraisal from whatever gain you make.
  
  

How Inherited Property Is Taxed

• According to the North America Military Financial Education Center, inherited property is always taxed at the long-term investment capital gains rate, but that rate depends on the type of property. While most asset gains are taxed at 15 percent, some are taxed as high as 28 percent. If you sold the property for less than the basis, you can take a capital loss, even though you probably didn't pay for the property originally.
  
  

Capital Gains and Losses

• You'll need to calculate your net capital gain for the year to figure out how much you'll be taxed. This is figured by subtracting the total of your net short-term capital loss and long-term capital loss carryover from the long-term capital gain you incurred for the year. If you sustained a loss, you can deduct up to $3,000 from your income. If your loss was more than $3,000, you can carry over this loss every year until it's fully deducted. Contact a tax advisor if you're unsure how to account for the gains or losses associated with your inherited property.