Income tax considerations for leaving assets to heirs


An inheritance is generally worth only what your heirs get to keep after taxes. When evaluating whom to leave property to and how much to leave to each person, you might want to consider how property will be taxed and the tax rates of your heirs.

Roth IRAs
Assets in a Roth IRA will accumulate income tax free and qualified distributions from a Roth IRA to your heirs after your death will be received income tax free. An heir will generally be required to take distributions from the Roth IRA over his or her life expectancy. If your spouse is your beneficiary, your spouse can treat it as his or her own and delay distributions until after his or her death. So your heirs will be able to continue to grow the assets in the Roth IRA income tax free until after the assets are distributed, any growth occurring after funds are distributed may be taxed in the future.

Appreciated capital assets
When you leave property to your heirs, they generally receive an initial income tax basis in the property equal to the property’s fair market value (FMV) on the date of your death. This is often referred to as a “stepped-up basis,” because basis is typically stepped up to FMV. However, basis can also be “stepped-down” to FMV.

If your heirs sell the property with a stepped-up (or stepped-down) basis immediately after your death for FMV, there should be no capital gain (or loss) to recognize since the sales price will equal the income tax basis. If they sell the property later for more than FMV, any appreciation after your death will generally be taxed at favorable long-term capital gain tax rates.

Tax-deferred retirement accounts
Assets in a tax-deferred retirement account (including a traditional IRA or 401(k) plan) will accumulate income tax deferred within the account. However, distributions from the account will be subject to income tax at ordinary income tax rates when distributed to your heirs (if there were nondeductible contributions made to the account, the nondeductible contributions can be received income tax free). An heir will generally be required to take distributions from the tax-deferred retirement account over his or her remaining life expectancy. If your spouse is the beneficiary of the account, the rules may be more favorable.

Toxic or underwater assets
Your heirs might not appreciate receiving property that is subject to a mortgage, lien or other liability that exceeds the value of the property. In fact, an heir receiving such property may want to consider disclaiming it.

Life insurance and cash
Life insurance proceeds will generally be received income tax free. Your heirs can generally invest life insurance proceeds and cash they receive in any way they wish. When doing so, your heirs can factor in how the property will be taxed to them in the future.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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