By Dean Alexander
There are two issues that one has to deal with when we receive inheritance. The first is an estate tax issue and the second an income tax issue and they are not one. You may be exempt form one but subject to another.
The two usually work against each other. Maybe the mechanics of the events will illustrate the point. Rich Uncle dies and leaves you a piece of land worth three hundred thousand dollars. The first question that people usually ask, or hopefully they will ask is: Am I going to pay estate tax on this money?
Clients that I come in contact with usually ask me how much income tax am I going to pay because I inherited the property. They think that inheriting this property is a taxable event, and a taxable event in their mind means income tax. They don’t differentiate between income tax and estate taxes. In 2011 property inherited up to one million dollars would be exempt from income taxes.
Notice that I said that you inherited property worth three hundred thousand dollars. How did you determine this amount? And what is the big deal about this amount anyway? You may determine this amount by looking up the county tax roll for that year or if the amount is large it could be determined by an appraisal.
This amount can cause you a tax problem if you don’t pay attention. This amount will be your basis if you sell the property two years form the time you inherited it. Basis is something like your purchase price. You will be regarded as if you purchased the property for three hundred thousand dollars. So if you sell it for three hundred and fifty dollars, your gain is fifty thousand dollars.
When do you value the property? You can value the property the day you inherit it or any other date within six months from the date of death. Why the choice? Like I said the value of the property at the time of inheritance will determine your basis (think of cost).
So the higher the basis the better off you are. In the example above, if your basis at the time of death was three hundred fifty thousand instead of just three hundred your gain on the sale of the property would have been zero. So the higher the basis the better tax relief or tax help you get from the valuation.
Remember when I said above that the estate taxes and the income taxes work in the opposite direction? Now it is time to explain. As I said above to avoid income taxes upon sale property that you inherited you would want to push the value up. The higher you push, the higher the amount it cost you to purchase the property (I am using the analogy of purchase). And the higher the cost, the less income taxes.
But can we push the price up forever? Not quite. As I said above, you had a limit of exempt estate taxes. If you push the value above the one million to avoid income tax, you will fall into the net of estate taxes. Any amount above the million will be taxed at 55%. So the best tax resolution is one that has to weigh both considerations.
If you find yourself owing back taxes as a result to your inheritance, you may be able to negotiate an IRS settlement such as offer in compromise or an installment agreement. But you must ask your CPA or IRS tax attorney to take some sort of initiative to avoid collection actions such as levy or garnishment against you because of the tax debt.
Summary: The best tax resolution for inheritance is to balance the estate and income tax consideration. You can even negotiate an offer in compromise for the new tax debt.