Bad news: your uncle dies. Good news: he left you money and a house. You’re also a beneficiary on a life insurance policy he had. Bad news: he named you as the executor of his estate, so you have to fill out paperwork now that he’s gone.

When your uncle died, he left an estate. Think of a figurative suitcase filled with the things he left: stocks, an interest in a partnership, the house. As the executor, you have the responsibility of passing out the assets, or figuratively emptying the suitcase.

Estate Tax

When the estate was created, it was subject to the estate tax, defined at I.R.C. §§ 2001-2801.

One of your responsibilities as executor is paying the estate tax. You’re unlikely to pay it, though, because estates are exempt from taxation unless the fair-market value of the estate is more than $11.4 million (in 2019). If your uncle’s estate is worth that amount or more, find a good estate attorney (you can call me for a recommendation) and file the return.

Until the assets are distributed, the estate exists as another taxable person. This means that if the tenants at your uncle’s house are still paying rent, that rent is taxable income to the estate. As the executor, you will need to file an income tax return and pay income tax on the rent. Tax rates are different for estates than for individuals, so get a good advisor here.

If you don’t pay the estate tax and the income tax in these scenarios, you as the executor will become personally responsible for those taxes.

No Income Tax

You are also likely to inherit some of these assets, that is, you will take them out of the suitcase and own them yourself. That’s income to you, and Congress could tax this transfer, but it doesn’t. See I.R.C. § 102. In fact, it gives a pretty good break here: it steps up the basis in the asset as of the date of death.

What does it mean to “step up the basis?” Let’s say you inherit your uncle’s house. He bought it in the 1970s and paid $50,000 for it. That (plus any money he paid for improvements to the house) constitutes the “basis.” When he died, the house was worth $1 million. The IRS would compute a $950,000 capital gain here. The government usually taxes capital gains as income. But because of the basis step-up, you receive the house with a basis of $1 million. If you hold onto the house and sell it years later for $1.5 million, you will have a capital gain of $500,000 on it, rather than $1,450,000.

The same thing happens to all assets you inherit: stocks, business interests, cars, and so on.

Life Insurance

We can’t forget the life insurance policy. Let’s say that pays out $800,000 to you. That’s income, but it’s not taxable income under I.R.C. § 101. So you get that money for free.

It’s also not part of the whole estate. So if your uncle’s estate is worth $11 million, and you get the $800,000 life insurance policy, you won’t need to file an income tax return.

I have much more to say about some of these issues. Next up: how the IRS values your uncle’s estate.

September 27, 2019