TurboTax / Tax Calculators & Tips / All Tax Guides / General Tax Tips / How to Handle a 2010 Inheritance

How to Handle a 2010 Inheritance

Updated for Tax Year 2010


OVERVIEW

Note: The content of this article applies only to 2010. It is included here for reference only.

Did your family inherit an estate in 2010? If so, you have a rare opportunity: You can opt to use either the 2010 or 2011 tax rules. For inheritors of large estates, selecting the right approach could result in major tax savings.


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.

2011: Estate tax and step-up come back

The tax compromise legislators hammered out in December 2010 reinstated the estate tax, with an exemption of $5 million per person. (In other words, only the amount that exceeds $5 million is taxed.) The new law also brought back the full step-up rule.

Your choice is relatively straightforward, even if the math involved may not be. You can:
•    Use the 2010 rules, which may involve capital gains liability, or
•    Use the 2011 rules, which may trigger estate tax.

To make the most prudent decision for your specific situation, calculate the tax using both systems and see which would result in a smaller slice of your pie going to the IRS.

Choosing the right tax rules for your situation

Which tax rules are most beneficial depends largely on the estate you’re inheriting. Consider the following scenarios:

The estate is worth $5 million or less.
In this case your decision is a no-brainer, as long as the deceased’s full estate-tax exemption is intact. (If the deceased made very large gifts during his or her lifetime they could have reduced the exemption.) You’ll want to go with the 2011 rules, because the full value of the estate falls within the exemption—meaning none of it is exposed to estate tax. If you used the 2010 rules instead, your inheritance could include large, taxable capital gains. Choice: 2011 rules.

The estate is worth more than $5 million and its assets appreciated less than $1.3 million from their original cost basis.
Again, this scenario presents a relatively easy choice. If you select the 2011 rules, you’ll most likely pay estate tax on the amount that exceeds $5 million. If you opt for the 2010 law, you’ll have no estate tax. What’s more, appreciation on the assets falls within the amount you can step up—resulting in a tax-free transfer. Choice: 2010 rules.

The estate is worth more than $5 million and contains more than $1.3 million in embedded capital gains.
This situation requires a good deal of number-crunching by a tax professional. If you choose the 2010 rules, you’ll face capital gains tax when you sell any assets to which you don’t apply your $1.3 million step-up. If you go with the 2011 rules, you’re likely to pay estate tax on the amount in excess of $5 million.

Essentially, you have to decide which makes more sense: to pay estate tax on some of the inheritance at a rate of up to 35%, or pay capital gains tax on some of the inheritance when you sell assets (currently a top rate of 15%, although that could change). Consult with your tax professional and attorney to determine the best course of action for you. Choice: 2010 rules if capital gains tax would be lower than estate tax; 2011 if capital gains tax would be higher than estate tax.

Your tax professional and attorney can help you factor state inheritance tax systems into the equation as well: Many had an estate tax holiday for 2010 but have reinstated the tax in 2011, with exemptions and rates varying from state to state. Whatever your decision, you have until September 17, 2011—nine months from the day the new estate tax law came into being—to file with the IRS.  
 

Get every deduction you deserve

TurboTax Deluxe searches more than 350 tax deductions and credits so you get your maximum refund, guaranteed.

For only $54.99*
Start for Free

Looking for more information?

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.


Security is built into everything we do
Here's how
* Important Offer Details and Disclosures
  • Filing Deadline: IRS filing deadline for tax year 2015 is April 18, 2016 (except for residents of Massachusetts or Maine, where the IRS filing deadline for tax year 2015 is April 19, 2016).
  • Try for Free/Pay When You File: TurboTax online and mobile pricing is based on your tax situation and varies by product. Free 1040EZ/A + Free State offer only available with TurboTax Federal Free Edition; Offer may change or end at any time without notice. Actual prices are determined at the time of print or e-file and are subject to change without notice. Savings and price comparisons based on anticipated price increase expected 3/18/16. Special discount offers may not be valid for mobile in-app purchases.
  • TurboTax CD/Download products: Price includes tax preparation and printing of federal tax returns and free federal e-file of up to 5 federal tax returns. Additional fees apply for efiling state returns. E-file fees do not apply to New York state returns. Savings and price comparison based on anticipated price increase expected 3/18/16. Prices subject to change without notice.
  • Anytime, anywhere: Internet access required; standard message and data rates apply to download and use mobile app.
  • Fastest refund possible: Fastest tax refund with efile and direct deposit; tax refund timeframes will vary.
  • Pay for TurboTax out of your federal refund: A $X.XX Refund Processing Service fee applies to this payment method. Prices are subject to change without notice. This benefit is available with TurboTax Federal products except the TurboTax Home & Business/QuickBooks Self-Employed bundle offers.
  • About our TurboTax Product Experts: Customer service and product support vary by time of year.
  • About our credentialed tax experts: Live tax advice service is available via phone for your toughest tax questions; fees may apply. Service, experience levels, hours of operation and availability vary, and are subject to restriction and change without notice. Not available for TurboTax Business customers.
  • #1 best-selling tax software: Based on aggregated sales data for all tax year 2014 TurboTax products.
  • Most Popular: TurboTax Deluxe is our most popular product among TurboTax Online users with more complex tax situations.