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Nobody likes to pay taxes. If done
incorrectly, though, the way you inherit an asset can result in you
needlessly paying tens of thousands of dollars in taxes. Knowing
some simple rules will reduce your tax bill and allow you to keep
more of what you inherit. And it will also keep you from creating
tax headaches for loved ones to whom you wish to gift assets.
Whenever an asset is sold, Uncle Sam wants to collect capital gains
tax. And that tax is figured using cost basis. Cost basis refers to
how much money you invested in a given asset. When sold, the cost
basis is subtracted from the amount received to determine the gain
or loss. Your amount of gain or loss then determines how much you
will pay in capital gains tax.
If you buy an asset for $10,000 and sell it for $25,000, your cost
basis is $10,000 and the taxable gain is $15,000. Currently, the
highest capital gains tax rate is 15%, which means you’d owe capital
gains tax of $2,250. Losses can be used to offset other gains, but
we won’t get into that in this article.
Determining the cost basis can get complicated. If you buy an asset
and add money to it, your cost basis increases. If it’s a mutual
fund and you have the dividends reinvested, that adds to your cost
basis. If you sell a portion, that affects your cost basis as well.
This means that it is important to keep track of the amounts you
paid and received on all of your assets.
An asset can be many things, not only stocks and bonds but also
houses, property, jewelry, coins, artwork, etc. Legally, you are
required to pay capital gains tax whenever an asset is sold at a
profit. In fact, 1099’s are issued whenever investments like real
estate, stocks, bonds, and mutual funds are sold.
Here’s where people lose thousands of dollars. If someone gives you
an asset, you ‘inherit’ the giver’s cost basis in that asset. So if
mom gives you $10,000 of stock that she’s owned for years, you
inherit her cost basis and are responsible for paying the capital
gains tax on it when you sell it. If she only paid $1,000 for that
stock and you sell it for $10,000 then you will owe taxes on the
$9,000 gain.
On the other hand, let’s say you inherited that stock from mom after
her death (through her estate). Then your cost-basis would be the
stock’s market value at that time. This is called ‘stepped-up
basis’. So, even if mom only paid $1,000 for the stock, if it is
valued at $10,000 when you inherit it you can sell it and not owe
any capital gains tax. You just legally avoided the Tax Man!
This stepped-up basis is the government’s way of making up for
people having to pay taxes on the transfer of their wealth. But
estate tax laws are in a state of flux. Under current regulation,
the stepped-up basis disappears in 2011. However, there’s some talk
in Congress of doing away with stepped-up basis altogether,
especially since the death tax only affects estates that are larger
than $1,500,000. Most likely, if Congress ends the estate tax for
all but the largest estates, they will collect revenues from smaller
estates by abolishing stepped-up basis.
There are situations where it is better to have an asset given to
you instead of it being inherited. It all depends on the size of the
estate. Death taxes range from 37% to 50%, while capital gains tax
rates are capped at 15%. So if an estate is going to be worth less
than $1,500,000 then there will be less tax paid by inheriting an
appreciated asset through the estate. If an estate will be worth
more than $1,500,000 then less tax will be paid on that appreciated
asset if gifted to you prior to death.
I’ll provide several examples in my next article that will clearly
illustrate real-life situations. That way, you will be able to more
easily determine which course of action you should take and can save
thousands of dollars in the process! There’s no reason to pay tax
when you don’t have to!
I’ll personally answer your financial questions. Go to
www.guardingyourwealth.com and click on ‘Ask Jeff’.
In addition to being a nationally syndicated columnist and Certified
Financial Planning Practitioner, Mr. Voudrie provides personal,
private money management services to clients nationwide. |
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