Q         Dear Rick:

I just received an inheritance of over $250,000.  The money is from my aunt’s estate. She passed away over five years ago.  Her only living relative in addition to me was other nieces and nephews.  My inheritance came from the sale of her home.  She had lived in the house for over 50 years.  The cover letter that I received with the check from my cousin said that I am responsible to pay any taxes owed as a result from the sale of the home.  My aunt lived in the house for over 50 years and I have no idea what she originally paid for it.  Hopefully, you can help me figure out what I owe in taxes.

Al

A         Dear Al:

I have some good news for you: you won’t have to pay taxes on the money.  The total $250,000 you received is income tax free.

Many people are confused with the taxation of inheritances; they confuse it with estate taxes.  These are two different taxes and one generally has nothing to do with the other.  For example, you could be in a situation where the estate pays zero taxes but the beneficiaries have to pay income taxes, or a situation where the estate is liable for taxes but the beneficiaries pay no taxes.   It all depends upon the assets and the situation.  Estate taxes are paid by the estate and are based upon the fair market value of the estate upon death.  For the great majority of people, estate taxes are no longer an issue as the current exemption now is well over $5 million per person.  On the other hand, a beneficiary can be subject to income taxes if they inherit a tax deferred type of account.

As a beneficiary, you typically inherit property income and estate tax free.  The one major exception to the rule deals with tax deferred accounts like Traditional IRAs or 401(k)’s.  If you inherit one of these accounts the money is taxable to you as ordinary income.  For example, if you inherited a $25,000 IRA that $25,000 would be taxed as ordinary income to you.  Regardless of whether the estate itself paid estate taxes or not, the beneficiary would be subject to income taxes.

If you inherit something like an annuity that is not within a qualified retirement account such as an IRA, then the tax liability is the deferred income.  For example, if you inherited a $25,000 annuity and the original purchase price was $10,000, then $15,000 would be taxed to you as ordinary income.

You may ask yourself why your cousin told you that you have to pay taxes on the sale of the house when there are no taxes due.  I don’t know, but one thing I do know is that most people who give tax advice shouldn’t.  Remember, tax laws are not stagnant, they’re ever changing.  Just because something was the law last year doesn’t mean it’s the law this year.  Therefore, people who don’t stay current should refrain from giving tax advice and those who receive tax advice should be very cautious as to whom they seek advice from.

Good luck!