They may be surprised at the total value of the assets they inherit. If their parents were diligent savers and held onto to the houses they bought when the children were young, the appreciation can be quite impressive. It might not put them into the same league as Bill Gates or Warren Buffett, but it's not an inconsequential sum.
These heirs -- let's call them the "slightly wealthy" -- might also be surprised by the tax trouble they encounter when they try to sell some of their new wealth, since they will be facing the stricter stepped-up-basis rules.
And they undoubtedly will be shocked to discover that, while the estate tax and inherited property basis are causing them unforeseen IRS issues, individuals who inherit substantially larger amounts in 2010 will be reaping greater rewards from the estate tax repeal.
The new wealth gapThe window of wealth that's likely to produce the biggest estate headaches, according to the analysis from the minority staff at Ways and Means Committee, is $1.3 million to $5 million in inherited property.
To see how the new, slightly wealthy will be hurt if they inherit in the year the estate tax is repealed, you have to look at current tax laws governing estates and capital gains.
When you sell property, to determine any potential tax, you must figure your gain by subtracting what the asset was worth initially, known as its basis, from the sales price you get. For example, if you paid $10,000 for a stock and then sold it for $25,000, you would owe tax on the $15,000 gain. At the typical 15-percent, long-term capital gains rate, that's $2,250.
In any year before 2010, recipients of inherited property get a step-up in basis no matter how much it's worth. "Right now this year, if a person dies with $2 million worth of stock that went up 10 times in value, it would be completely exempt and the heir could turn around and sell it without any tax because of step-up basis," says William Massey, senior tax analyst at RIA, a Thomson business and provider of tax information and software to tax professionals.
Basically, the step-up basis rule means you don't have to pay for your parent's investing acumen that grew $200,000 into $2 million. That one provision saves you from a tax bill of $270,000 on $1.8 million in profit.
Family home could mean inherited tax costsThe greater the appreciation of an inherited asset, the more valuable the step-up option becomes. And nowhere, especially in recent years, has appreciation been greater than in real estate.
In many cases, an estate's largest asset is the family home. The children who are bequeathed the house often decide to sell the property so they can have cash to use for other needs, such as a child's educational costs. But if the home has skyrocketed in value over the many years their late parents lived there, then the $1.3 million cap applied in 2010 could mean they'll face a sky-high tax bill on its sale proceeds.