Ask the Expert: Heirs hit by capital gains taxes

I've heard that for many people, taxes are actually higher because we now have no federal estate tax! Is that true?

Yes. The federal estate tax law that expired in 2009 included an unlimited capital gains tax exemption on most inherited assets. That exemption expired, too. The result: Many heirs now are subject to capital gains taxes they wouldn't have owed last year.

In 2009, if you inherited a capital asset - a house, a stock, a stamp collection - its value for tax purposes was what it was worth when the previous owner died. Let's say your father left you a $2 million stock portfolio for which he originally paid $200,000 and a house worth $695,000, for which he paid $40,000. Your $2.695 million inheritance includes $2.455 million of appreciation. Your capital gains tax on that appreciation when you sell the assets: zero. Your federal estate tax: also zero. Only estates worth more than $3.5 million were federally taxed.

But in 2010, the capital gains exemption is capped at $1.3 million of appreciation on assets left to nonspouses and $3 million of appreciation on assets left to spouses. If you inherit that estate from your father now, you owe capital gains tax on $1.155 million of your inheritance ($2.455 million of appreciation reduced by a $1.3 million exemption).

Extremely wealthy people come out ahead: They now pay a low capital gains tax rate instead of a high federal estate tax rate. But people who inherit between $1.3 million and $3.5 million from their parents have lost out. They weren't subject to federal estate tax in the first place, and they now owe capital taxes they didn't owe before.

The bottom lineMany taxpayers will benefit when Congress reinstates the federal estate tax and the unlimited capital gains exemption on inherited assets.

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