The 2010 rules: No estate tax, but potential capital gains tax
There was no estate tax in 2010. Still, people inheriting money weren’t entirely off the hook. The 2010 laws also cut out an important provision that effectively prevented capital gains taxes on inherited estates.
To calculate capital gains tax, the IRS first calculates the difference between an asset’s sale price and its original price, called its cost basis. The result is the asset’s appreciation, which is taxed at capital gains rates.
In years leading up to 2010, inherited assets were treated as if they had been purchased at the value they had when the original owner died. For example, say your uncle left you stock he bought at $10, and at the time of his death the stock traded at $100. If you sold the stock, you would pay capital gains tax only on appreciation above $100. This provision, known as a “step-up” in cost basis, eliminated taxes on any gains that occurred during the original owner’s lifetime.
Last year’s law limited the step-up in cost basis to assets with appreciation of less than $1.3 million, or $4.3 million for inheriting spouses.
The lack of the full step-up provision means estate executors using 2010 rules have to determine the original basis of each asset—no easy feat in many cases. And when inheritors sell the assets, they pay capital gains tax on any appreciation from that original cost.
The resulting tax bill could be significant, especially in the case of stocks or real estate that had been in the family for decades.