Ask the Expert: Tax year is flexible with inheritance

In 2006, my mother transferred her condo to me and my siblings, reserving a life estate for herself. She died in September 2010. We sold the unit in March 2011. What are the tax rules for people who inherited property from a decedent who died in 2010? 

If you inherited from someone who died in 2010, you can elect to be taxed under 2010 rules by filing Form 8939. Otherwise, current rules apply.

In 2010 -- for just one year -- there was no federal estate tax, and no unlimited capital gains tax exemption on inherited assets. Estates of people who died in 2010 got a capital gains tax exemption on only up to $1.3 million of appreciation in assets left to non-spouses, and only $3 million of appreciation in assets left to spouses. Here's an example: Let's say Mom left you $1 million in stocks, originally purchased for $65,000; a $1-million house, purchased for $85,000; and a $695,000 condo, purchased for $125,000.

Your total $2.695-million inheritance includes $2.42 million of capital appreciation -- the increase in the value of the stocks, house, and condo since their purchase. Under 2010 rules, if you sell these assets for $2.695 million, $1.12 million of the proceeds ($2.42 million of appreciation minus the $1.3 million exemption) is subject to capital gains tax.

By contrast, current law imposes a federal estate tax on estates worth more than $5 million, and restores the unlimited capital gains tax exemption on inherited assets. Under today's rules, your $2.695-million inheritance doesn't incur a federal estate tax or a capital gains tax on the asset appreciation that occurred during Mom's lifetime.

The bottom line If you inherited an estate worth less than $5 million, current law works better for you than 2010 tax rules.

Websites with more information 1.usa.gov/lXQnlt and bit.ly/iSfEEo