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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

Inheritance and Tax Basis Rules

Inheritance and Tax Basis Rules

Inheritance tax is the cost basis calculation for inherited assets against taxes owed to the state. That being said, most estates are simply too small to be charged the federal estate tax applied only if the deceased’s assets are worth at least $12.06 million in 2021.

Most states do not have an estate tax—a tax levied on the estate itself—while others do not have an inheritance tax—tax assessed against those that receive an inheritance from the estate. Nevertheless, there are a couple of states—Maryland, Pennsylvania, New Jersey, Nebraska, Kentucky, and Iowa-= that still tax a percentage of inherited assets from the deceased’s estates. A dozen other states, as well as the District of Columbia still tax estates.

Whether an inheritance is taxed and at what rate typically depends on a couple of factors such as your relationship to the deceased and the asset’s value.

Is There A Difference Between Inheritance Tax and Estate Tax?

While both inheritance and estate taxes are colloquially known as death taxes, there are various differences between them. An inheritance tax is typically levied on the value of the inheritance from the deceased to the beneficiary, while an estate tax is levied on the value of the deceased’s estate (financial and real assets).

Inheritance Cost Basis

Calculating cost basis for estates can typically differ from those used in other tax-related issues. When calculating capital gains on assets owned, the cost basis is represented as the asset’s original value with a couple of adjustments. 

Alternative Valuation Date

If the assets’ value at the time of transfer or since the date of the death have dropped, the estate administrator can choose to go with a different valuation date for the estate. Doing this, extends the valuation to 6 months after the date of death. This delay can help lower the tax due on the inheritance. 

With this delay, heirs to the estate are able to find out if a reduction in asset value will occur at a later date, after the relevant tax return is due. For this to happen under estate law, the estate’s value would have to drop in value by the 6 month mark. If this isn’t the case, then the regular valuation date must be applied.

Fair Market Value

When you inherit certain assets, the cost basis is typically equal to the fair market value of the asset or property at the time of the deceased's death. It can also be when the actual transfer of assets was made. Fair market value can be defined as the price an asset or property would command in the marketplace, considering sellers and buyers who know about the property. The interested parties should also have a reasonable amount of time to conduct the transaction.

Choosing the right valuation date

There are a couple of disadvantages attached with choosing the alternative valuation date. The timing, for one, must apply to all of the inheritance. This means that you cannot pick and choose which assets it is applied to. Furthermore, the lower valuation it creates can form the cost basis for any capital gains that the inherited might incur at a later date. 

This can result in an even larger capital gains tax bill compared to if a higher valuation was chosen when the assets were inherited. Nevertheless, there are some exceptions to be had when the valuation rules apply to assets related to closely held businesses or agriculture industry. To this end, it is very important that you research the valuation rules before deciding how and when to carry out a valuation. 



Jim McClaflin, EA, NTPI Fellow, CTRC
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