It Was The Best of Times; it was the worst of times. – Charles Dickens
It’s time for a tale of two inheritances. Settle in and get comfortable because the next two decades promise more inheritances than words in a Dickensian novel. Cerulli & Associates estimate approximately $84 trillion in assets will move from Baby Boomers to Gen Xers and Millennials by 2045.
Some inheritances will go smoothly, and others, well, won’t. Take these scenarios, for example, that we heard about recently:
A Millennial inherited a $1 million trust when his father passed away. However, due to a lack of coordination between his father’s attorney and tax officer, he also inherited $600,000 in unrealized capital gains. You see, one of the biggest mistakes when designing a trust is a lack of foresight about tax implications for the inheritor.
On the other hand, a Gen Xer inherited $4 million in assets after his mother died. His father had passed away a few years earlier, and the mom’s advisor had the foresight to combine their trusts after the father’s death (and benefit from his step-up) to get another step-up at the mother’s death – so that her son didn’t face enormous tax implications.
SIDE NOTE: A step up isn’t just a series of dance movies starring Channing Tatum. When it comes to trusts, a “step-up” is a tax advantage that can occur when assets are transferred through inheritance. It pertains to the adjustment of the tax basis of assets to their current fair market value at the time of inheritance.
Let’s dig a little deeper and look at four common scenarios and the tax implications of each:
If you inherit an IRA… The tax implications depend on the type of IRA, your relationship to the deceased owner, and the options you choose. Generally, if you inherit a traditional IRA, distributions are subject to ordinary income tax, while inheriting a Roth IRA may have tax-free distributions if certain conditions are met.
If you inherit property… You may not owe any immediate taxes on the inherited property itself, but you could be subject to taxes on any income generated by the property. If you sell the property at a later date, you may incur capital gains tax on the difference between the inherited property’s value at the time of inheritance and its sale price.
If you inherit a trust… Generally, beneficiaries may be subject to income tax on distributions from the trust, while the trust assets will not receive a step-up in basis because the trust assets were not included in the decedent’s estate.
If you inherit a portfolio of stocks… The cost basis of the inherited stocks is “stepped-up” to their fair market value at the time of the decedent’s death. If you sell the inherited stocks, you may be subject to capital gains tax on the difference between the stepped-up cost basis and the sale price.
The truth is an inheritance can create stress at a moment in your life that is already full of emotion. But you’re not in this alone. We’re here to help you and your family proactively plan, coordinate, and press the easy button on difficult conversations.
If you would like to discuss these concepts further, simply click here to get in touch. We always appreciate hearing from you.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Investment advice offered through Integrated Partners, doing business as PRISM Financial Strategies, a registered investment advisor. Securities offered through M.S. Howells & Co., member FINRA/SIPC. M.S. Howells & Co, Integrated Partners and PRISM Financial Strategies are separate entities.
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