Inheritance reporting, like almost everything involving the IRS, is a tricky subject. The answer is usually "it depends." In inheritance cases it primarily depends on what type of income it is and if it has earned any income since you inherited it.
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Items, whether received as a gift or an inheritance, are generally not taxable to the receiver. The IRS refers to these items as "property". Property can include everything from knick-knacks to stocks, bank accounts, cash or real estate. The value of property you inherited is not considered income and is therefore not taxable. However, any income you receive from the property after you inherit it is taxable.
As far as inherited assets are concerned the IRS is primarily concerned with the "basis" of the property. In most cases your "cost basis" of the property is the value on the day the decedent died, not on the day you actually received it. The only exceptions to this would be in rare instances where the executor of the estate chose an alternative valuation, or if you or your spouse gave the property to the decedent within one year prior to his death. Executors may choose alternate valuations when property is difficult to value such as a stock being thinly traded or a small business or farm that is not publicly traded.
Since your cost basis is assumed to be the value on the date of death, the difference between the value on that date and the current value will determine your gain or loss. In addition to taxes on income generated, you would also owe taxes on any gain when you sell the property. In the same way, a loss could be used to offset other gains you may have. These gains or losses are considered "long term" regardless of how long you actually held the property.
Interest and Dividends
It may take a while to actually receive your inheritance. During this time the estate may have to go through probate or the executor may have to liquidate assets, etc. The assets may also be earning income like dividends or interest during this time.The trustee of the estate is responsible for sending you a Schedule K-1 that states your share of any income generated during this period. You will be responsible for including this income on your tax filings and paying any tax liabilities associated with it.
Estate and Gift Taxes
Large estates are subject to tax but generally that tax is the responsibility of the trustee or executor that is handling the distribution of the estate. Taxes will be taken out of the estate before it is distributed to the beneficiaries. The definition of a large estate is constantly changing. It was £1.0 million in 2004 to 2005, £1.3 million in 2006 to 2008 and changed to £2.3 million on January 1, 2009 and could drop back down again.
Gift taxes are payable by the giver in the event that he gives more than a certain amount in any one year to a single person. In 2009 the gift tax limit was any gift of more than £8,450 per year per person.
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