By Anthony Diosdi
Many U.S. income tax questions arise in connection with the receipt of inherited property. These questions generally include whether the recipient must include the value of such property in gross income for U.S. tax purposes and what will be the U.S. income tax consequences of the recipient’s subsequent disposition of the inherited property. This article will briefly summarize the more relevant U.S. income tax consequences in connection with inherited property with emphasis on property inherited from a foreign individual. Although the U.S. has a transfer tax regime that could impose an estate tax upon the transfer of the property of a decedent, the estate tax is generally imposed on the estate of a decedent and not on the recipient. However, the estate tax generally reduces the value of an estate. Thus, the estate tax could indirectly impact a beneficiary of an estate. As a general rule, for U.S. income tax purposes, the value of property acquired by bequest, devise, or inheritance is not taxed. However, this general rule does not apply to income generating property.
Another benefit of inherited property is what is commonly known as a “step-up” basis of property. The determination of the basis (or adjusted basis) of property is necessary primarily for determining gain or loss on the sale of property. Property acquired from a decedent typically has a basis in the hands of the recipient equal to its fair market value as of the decedent’s date of death, or if elected, the alternative valuation date (6 months from the date of death). For example, if the decedent owned property with a fair market value of $500,000 on the date of death and the decedent’s basis in such property was $100,000, the decedent would have realized a gain of $400,000 had he sold such property immediately before death. However, because of the step-up in basis, the individual receiving such property from the decedent could sell such property for its fair market value immediately after the date of death without realizing any gain.
Reporting Requirement for a Foreign Gift
A U.S. person is required to report the receipt of gift(s) from a foreign donor or foreign estate to the extent the aggregate annual gifts exceed $100,000 on a Form 3520 to the Internal Revenue Service (“IRS”). The IRS may assess a penalty of 5 percent of the value of the gift for each month the gift is unreported (up to a maximum of 25 percent).
Reporting Distributions from and Contributions to Trusts and Purported Gifts from Foreign Corporations or Foreign Partnerships
If a foreign trust makes a distribution to a U.S. person beneficiary, the beneficiary should report the amount as a distribution from the foreign trust rather than a gift. For anyone to whom this rule may apply, such a person should be aware that the foreign trust related reporting requirements are more extensive than the foreign person gift reporting requirements. All distributions from a foreign trust to a U.S. person beneficiary must be reported, regardless of the amount, and a 35 percent penalty (based upon the gross amount of the distribution) applies to unreported payments. Contributions of property by a foreign U.S. person is treated under U.S. tax law as receiving the contribution in the year of transfer (e.g., a U.S. person has the right to withdraw such contribution). Any such contribution to a domestic trust is treated under U.S. tax principles as “owned” by a foreign person are specifically not reportable, but in order to avoid penalties, any U.S. person should report any distributions from such a trust as a gift. All planned contributions to and distributions from foreign or domestic trusts should be reviewed by counsel before they are made as should any planned gifts to a U.S. person via a foreign corporation or partnership.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: firstname.lastname@example.org.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.