If you have received an estate or a bequest from a deceased family member, you are liable to pay 3 taxes: estate tax, inheritance tax, and capital gains tax. An inheritance is subject to the estate you have received from a deceased family member, given it exceeds a specified value set by the federal and state government.
On the other hand, the estate tax refers to the tax that is subject to the value of the estate before it is handed over to the heirs. Technically, it is not paid by the heirs but by the estate. However, the estate tax reduces the value of the inheritance altogether.
Taxes at the federal level that you have to pay on inheritance
Ideally, the Internal Revenue Service cares most about the capital gains tax you owe after you own the estate. Technically, the federal government does not impose an inheritance tax. The property you will owe will not be subject to income tax. For instance, if your father has left you $50,000, it is not considered as income. Therefore, you won’t be liable to pay inheritance tax on it.
Inheritance tax at the state level
There’s nothing much to worry about inheritance tax on the property/estate you have received from your deceased ancestors unless you live in the following 6 states:
- New Jersey
However, if the deceased lived in the other 44 states and leaves you a gift or estate there, you can collect it as a gift without having inheritance tax levied on it. This law is applicable even if you live in the above-mentioned states.
There are exemptions on inheritance tax in all the 6 states. For instance, New Jersey and Kentucky work on the class beneficiary system. If you are a spouse of the deceased person, you come under class A beneficiary. None of the states you live in will collect the inheritance on you.
However, the states of Pennsylvania and Nebraska collect inheritance taxes from the grandchildren as well as the children of the deceased family member.
Federal income and state income taxes
You are not liable to state your inheritance to federal or state income tax returns because inherited money is not considered as taxable income. However, the property or estate you inherit might be subject to inheritance tax if you live in the 6 states mentioned above.
The capital gains tax
The capital gains tax is applied to the difference between the actual value of the estate and the value you sell it for. If you sell it in less value, the capital is lost and hence, no tax is due. Otherwise, tax is levied on the difference value you sold the asset for.
The long-term capital gains tax rate is technically better than taxes individuals are subject to on their monthly incomes.
For instance, you inherit an estate that’s valued at $250,000. Let’s say you sell the property for $275,000 10 years after the death date. In this case, you owe a long-term capital gains tax on the $25,000 you made.
Even if the deceased purchased the value for $90,000, your capital gains tax won’t be calculated using this value.
Federal estate and state estate taxes
Federal estate and state estate taxes might also come in due if you inherit a property. But the good news is, the state exemption is $11.4 million. An estate won’t be subject to tax if the value of that estate is less than $11.4 million.
If any estate owes state taxes, it must be paid before you can inherit the estate.