Q: In your weekly Newsday column, you recently wrote ‘After Congress passes a new federal estate law, the capital gains tax exemptions on inherited assets will be unlimited.’
I know there is no
inheritance tax this year, but I thought there will be one next year. How do
you know a new bill will approve an unlimited capital gains tax exemption? Does
an unlimited exemption apply only to inherited homes, or does it include
inherited stocks/bonds/cash? Does an unlimited exemption apply to assets
inherited by children, relatives, or non-relatives, or only to those inherited
by spouses? – DH via email
A: My statement wasn’t based on confidence about what a new bill will include. It’s based
on a tax law that’s already on the books.
Just to be clear about this, your question
involves two entirely different taxes. One is the federal estate tax -- also
known as the inheritance tax – which expired at the end of 2009. As you say,
there is no federal inheritance tax this year.
For many years, the
Internal Revenue Code has said that with few exceptions, assets that are part of your taxable estate pass to your heirs –
to all your heirs, regardless of their relationship to you – at their market value
on the date of your death.
Your taxable estate is everything you own when you die, even if it isn't big enough to incur an
inheritance tax. In other words, the unlimited capital gains tax exemption applied to every estate.
The result: Your heirs could sell inherited assets -- including houses, stocks,
bonds, bank accounts, stamp collections, and diamonds -- for a price equal to their market
value at the time of your death without owing any capital gains tax. (The
exemption doesn’t include assets on which you would have owed ordinary income
taxes if you’d lived: Your heirs owe taxes on withdrawals from your retirement
accounts, just as you would.)
If your
father owned a house that he bought for $20,000 and he sold it for $250,000, he
would owe a capital gains tax on a $230,000 profit. However, if he left you
that house in his will, you’d inherit it at its ‘stepped-up’ $250,000 value.
You could sell it for $250,000 without incurring any tax.
This year, nobody has a taxable
estate because there's no federal estate tax. Therefore, no one gets an unlimited capital gains exemption. If you die in 2010, there's a capital gains exemption on only up to $3 million of the appreciated assets that you leave to your spouse, and only on up to $1.3 million of assets you leave to everybody else.
The unlimited exemption is
still in the Internal Revenue Code, however. It will apply again as soon as estates are
subject to federal estate tax. That will be in 2011, even if Congress doesn’t
pass a new estate tax law. In the absence of a new law, we will revert to the
law that existed before the last one expired. That law imposes federal estate tax on estates
worth more than $1 million.
(c:) Lynn Brenner, All Rights Reserve
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