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What are the rules on taxing an inheritance?

We’re the heirs of an aunt who died without a will two years ago in California. The public administrator is handling sale and distribution of the estate’s assets. When the proceeds are distributed to us, are they subject to federal or state income taxes?

The answer depends on 1) whether the assets have appreciated in value or earned interest since your aunt’s death, and if so, whether the estate has paid taxes on that appreciation or income; 2) whether you receive distributions in the year of the sale, and whether that’s also the final year of the estate; and 3) the source of the income. Some states have special rules about income from the sale of businesses and real estate.

A simple example: The administrator sells stock for $20,000 more than its value on your aunt’s date of death. That $20,000 is a taxable gain. If the $20,000 isn’t distributed to the heirs in the year of the sale, the estate pays the tax. If the $20,000 is distributed in the year of the sale and the estate is closed, the beneficiaries pay taxes on their shares.

If the stock was worth $20,000 when she died and the administrator sells it for $20,000, there’s no gain; the $20,000 isn’t taxable. And if the stock is sold for $16,000, the $4,000 capital loss is divided among the beneficiaries in the final year of the estate, says Alan E. Weiner, a Melville tax accountant.

But you won’t need to guess about any of this. You’ll each receive Form K1, stating the tax liability on your distributions, whether it’s ordinary income or capital gains, and whether you must file NYS and California returns as well as a federal return.

THE BOTTOM LINE The estate administrator informs heirs of their tax liability on their distributions.


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