This year, New Jersey has eliminated the estate tax. For Class "A" beneficiaries, there’s no inheritance tax. Therefore, when Class "A" beneficiaries inherit their parents' residence and taxable accounts, is the inheritance at the stepped-up value, if it’s sold soon after?
nj.com’s recent article asks, “How will your inheritance be taxed?” The article explains that typically, the basis of property acquired from a decedent is its fair market value on the date of the decedent's death. This value is usually more than the decedent's cost basis. As a result, it’s called a "stepped-up" basis and it’s possible the basis could be lower.
Because of the step-up in basis, if you sell the property right after death, there’s typically no income tax consequence. The gain you’d report on the sale, is the sales price minus selling expenses, less the fair market value of the property at the date of death.
As far as investment accounts, the new basis of a security is calculated by taking the mean of the high and low price of the security on the date of death, rather than the close price. Let’s say that the decedent passed away over a weekend. The date of death value is determined by taking the average of:
- the mean of the high and the low value on Friday; and
- the mean of the high and the low value on Monday.
The financial institution will usually give you the investment’s value.
For taxable estates, rather than using the date of death, an alternate valuation date (the date six months after the date of death) can be chosen. In that instance, it must be used to value all of the assets as of the date. You can’t elect date of death value for some assets and an alternate value for others. The IRS also requires consistency in reporting. The basis utilized by the beneficiary as the value of the property received from the decedent, can’t be more than the value of the property reported on the decedent's estate tax return.
For any retirement accounts other than Roth IRAs, income tax must be paid when distributions are made to the beneficiary—like it would have had to be paid on distribution to the decedent. The value of the retirement account in the decedent's estate and/or passing to the beneficiary isn’t reduced by the income tax that will have to be paid on future distributions.
However, when you receive property as a gift, rather than the fair market value on date of death, you obtain the donor's basis in the property. Therefore, a subsequent sale of property received by gift, will likely have a greater income tax effect to you as the recipient than a sale of property that was inherited from a decedent.
Reference: nj.com (July 11, 2018) “How will your inheritance be taxed?”