Q: Will I face a tax bill if I inherit stocks, bonds, or mutual funds?
A: Death and taxes—few things are as certain, though in this case the link isn’t always a simple one.
When you inherit stocks, bonds, or mutual funds—or cash, for that matter—you won’t owe taxes on those assets. As long as the total value of the estate is under $5.45 million, the entire inheritance is exempt from federal estate taxes; above that, the estate pays the tax bill, not the heirs (this cut-off may differ in your state). But you could have to pay taxes on your windfall when it comes time to sell.
At that point, if the investment is worth more than it was at the time of your benefactor’s death, you’ll owe capital gains taxes on that difference—at a rate of up to 20%. When it comes to paying capital gains taxes on inherited money, there’s not much you can do to minimize the tab. That said, you could be strategic about when you sell, says Trish Evenstad, president of the Wisconsin Society for Enrolled Agents, part of the larger non-profit tax advocacy group, the National Association for Enrolled Agents.
“If you’re selling an asset right away, there probably won’t be a big gain on it, assuming the value of the asset doesn’t change a lot,”Evenstad says. “But if you hold onto the asset for 10 years and then sell it, there’s room for a bigger gain and a bigger tax.”
One strategy to spread out the tax bill is to sell the appreciated assets over time, thereby reducing the one-time capital gains tax hit, according to Evenstad. For example, if you inherited 1,000 shares of a stock and the price has gone way up since you inherited it, selling all the shares will trigger a big tax bill in a single year.
Spreading the sale over several years, however, would break up the amount you’d pay in taxes at once. And if you sell the assets during a year in which your income is lower than normal, leaving you in a lower tax bracket, you could also pay a smaller tax bill than you otherwise would. But if you’re earning the same income over time, spreading out the sale would mean you’re just paying the taxes in chunks, instead of taking the hit at once.
If you inherited an IRA, the rules are a bit different. You’ll owe ordinary income taxes on the money when you cash out the account, not a capital gains tax. The same goes for an annuity.
Most importantly, you should consult a tax professional before making any decisions about selling assets, and do so before the Dec. 31 tax year deadline.