Q: My sister passed away in January 2009. I am the beneficiary on some of her financial accounts and I have also inherited her house and other property. Is there any difference between the two when it comes to taxes? Aren’t there rules on certain amounts that can be taxed on an inheritance?

A: We’re sorry for your loss. Let’s start by talking about how assets get passed down.

When your sister placed you as the beneficiary on some financial accounts, you should have inherited those accounts automatically. With the proper documentation given to the financial institution holding your sister’s accounts, you would be entitled to use those funds as you would see fit.

If your sister owned her house in a trust, the trust could convey title of the home to you and you would become the new owner of the home. If the home was held in your sister’s name, you might need to have a probate court authorize the transfer of ownership from your sister’s estate to you.

Having said all that, your ownership of her house is one thing. The federal tax implication of each of those transactions is another. Your sister’s estate may be affected by federal estate taxes and you could be affected by other taxes.

Let’s start with the value of your sister’s estate as a whole. If your sister’s entire estate, including life insurance policies that were owned by her, is less than $3,500,000, your sister will not have to pay any federal estate taxes.

When your sister’s estate settles up with the IRS for any taxes, your sister would only owe federal income taxes on her earned income from the year before she died through the date of her death. Those would be the same federal income tax returns that your sister would have filed for those years had she still been alive.

Most people’s estates are well below the $3,500,000 threshold and are not affected by the federal estate tax. Each state treats estates somewhat differently, so there may be a state estate tax that is owed, depending on how big an estate she left.

What some people forget is that retirement accounts will generally be taxed at some point or another. If you are named as the beneficiary on any of your sister’s retirement accounts, you will pay federal income taxes on that money as you take it out. In some cases you can defer taking the money out over time to minimize the effect of any taxes but if you don’t follow the rules, you may have to pay federal income taxes on the whole amount you inherit, plus penalties.

If the accounts you inherited aren’t qualified retirement accounts (like a 401(k), 403(b) or a 457 account), you shouldn’t have to pay taxes on the money you receive as an inheritance. If the account is an account with mutual funds and stocks that are not held in a retirement account, the value of those mutual funds and stocks shouldn’t be taxed if you cash them out and sell them.

As far as the home is concerned, if you decide to sell the home, you shouldn’t have to pay federal income taxes on that sale provided you sell it within a year of the date you inherited the home. For more information, you can read articles at http://www.ThinkGlink.com/inheritance.

May 15, 2009