My Aunt died and the bank sold her house. Being her only surviving relative, the bank sent me a check for "excess proceeds" from the house sale. Do I owe any tax on this money?
Thanks,
Bill
Dear Bill,
Thank you for submitting your excellent question. Please accept our condolences on the passing of your Aunt. Unforeseen tax liabilities resulting from an out-of-the-blue windfall can be an unpleasant financial shock. Understanding the possible tax consequences of receiving property through inheritance may keep any shockwaves from creating a hole in your wallet. Whether a person owes taxes on the inheritance they receive will depend on the specific facts and circumstances surrounding the distribution. (Distributions are payments of cash or other types of property, like stock, collectibles, or real estate, made to a specific person.)
Based on the information provided in your question, we are assuming that your Aunt passed away without a trust. (A trust is an entity created to hold the assets for the benefit of a specific person or entity. It is generally administered by a person or entity known as a trustee.) Chances are, if your Aunt died with a trust, you would have received a letter from the trust administrator indicating you are listed as a beneficiary along with contact information you can use to address any questions or concerns. Since the bank sent you the "excess proceeds" from the sale of your Aunt's home because you were her only surviving relative, it implies your Aunt's estate may have gone through probate. Probate is a legal process where an executor administers a decedent's estate and the decedent's property is disbursed according to the decedent's will. (A decedent is a term used to describe a person who has died.) If the decedent did not leave a will, then generally, their property is distributed according to the state's rules where the decedent resided. Often when a person dies without a will or trust and their estate goes through probate, the probate court will distribute any excess property remaining, after all of the decedent's debts have been paid, to the decedent's next of kin.
If the estate went through probate, the trustee more than likely paid all of the estate's debts before making any other distributions. Debts would include any income taxes due on the sale of your Aunt's home. Under most circumstances, when a person passes, the assets they owned on the date of their death receive a new valuation. This new valuation, known as the property's basis, is the property's fair market value as of the date of the decedent's death. Often, property, like real estate, receives a "step-up" in basis, as homes tend to increase in value over time. More than likely, your Aunt's home was sold within a few months of her passing. If this was the case, the home might have sold for approximately the same price as it was valued at the time of her death. There was probably a loss on the sale when selling expenses are factored in, and no income tax was due.
Depending on the timing of your distribution and the circumstances surrounding the administration of your Aunt's estate, it is possible that any income tax due on the sale might not have been paid. If this happened, you might be responsible for a portion of any tax assessed on the sale. If this is the case, you should receive a document called a Schedule K-1. A Schedule K-1 will show how much income you are required to report on your federal and state income taxes.
Inheritance taxes are imposed on the person who received property from an estate. The tax is based on the property's value and how the beneficiary was related to the decedent. For federal purposes, inheritance taxes are a thing of the past and are no longer imposed. Most states have repealed their inheritance tax laws. Currently, there are only six states that still impose an inheritance tax: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. If your Aunt resided in one of these states, you might owe an inheritance tax on the distribution you received.
Unless the tax was not paid on any gain that might have incurred on the sale of your Aunt's home, or she was a resident of one of the six states that still impose an inheritance tax, there is a good chance you may not owe any tax on the excess proceeds you received. Again, keep in mind that your Aunt's home likely sold within a few months of her passing, so the basis and sales price may have been close to identical. And, when the selling expenses are factored in, there may have been a loss rather than a taxable gain. Because the bank used the term "excess proceeds," it is reasonable to assume that any income taxes due may have already been paid. The only way to be sure you do not have a tax liability is to contact the bank that issued the check and ask if you have any income tax reporting obligations on the distribution. At the very least, the bank should provide you with a letter explaining the source of the excess proceeds and if you have to report the distribution as income on your personal income tax return. You may also want to ask the bank if they will be sending you a Schedule K-1. When an estate is required to issue a Schedule K-1, a copy is also required to be sent to the IRS. So, you will want to make sure to include any income reported on Schedule K-1 on your 2021 income tax return. By doing so, you may stave off a future love letter from Uncle Sam.
Wishing you financial prosperity and many happy returns,
Jean Lee Scherkey, EA