An inheritance can provide a welcome financial windfall, especially if you are planning for retirement. However, holding on to valuable assets that you inherit may not always be the best decision. In many cases, disposing of them or even turning down an inheritance altogether may make more financial sense.

Essential questions

If you receive an inheritance, it is important to evaluate the asset (or assets) to determine how it might fit into your overall financial and retirement plan. Questions to ask include:

• What is the asset worth?
• How important is it to keep the asset? For example, is there any sentimental value?
• If you keep the asset, does it fit into your overall asset allocation strategy? Or, if you had not inherited the asset, would you have purchased it?
• Does the asset generate income?
• What liabilities, expenses or time commitment are associated with managing or maintaining the asset?
• What is your comfort level with the asset’s inherent risks?
• If you were to sell the asset, what would you net in after-tax proceeds? Inherited assets are generally entitled to a stepped-up cost basis (discussed below), which can minimize or eliminate capital gains taxes.

Often, individuals are better off selling inherited assets and using the proceeds to invest for retirement in a more efficient, lower-risk manner. For example, assume you inherit a small office building that is worth $2 million and has an original cost basis of $500,000 (the amount the decedent paid for it). There is no mortgage, but the building is struggling to find tenants. In addition, the property taxes, insurance and maintenance expenses are $75,000 per year. Inherited assets are entitled to a step up in the basis of the property equal to the fair market value after the date of death, in this case $2 million. Therefore, rather than invest the $75,000 expense per year in a building with an uncertain future, you may be better off taking advantage of the property’s stepped-up basis to sell it tax-free and use the proceeds to fund more efficient investments.

Related Read: What to do if You Inherit an IRA

Turning it down

In some cases, the best strategy is to refuse an inheritance altogether, using a qualified disclaimer. A qualified disclaimer under the Internal Revenue Code permits you to disclaim the asset, so that it is treated as though you never received it. 

For example, suppose you inherit an Individual Retirement Account (IRA) from a parent. Under the recent Secure Act and Secure Act 2.0 legislation that passed in 2019 and 2022 respectively, the distribution of the inherited IRA to a non-spouse beneficiary generally must be taken within ten years from the date of death. This may generate significant income taxes to you if you are in a high tax bracket. Assume that your child (your parent’s grandchild), however, is the contingent beneficiary of that IRA. If you turn down the inheritance, the IRA will go to your child. Assuming that your child is in a lower tax bracket, this will produce significant tax savings for your family.

Several factors come into play when deciding whether to accept or disclaim an inheritance, which will include personal, economic and tax implications.  It is imperative to review the costs and consequences of various scenarios before making the decision to accept, sell, or disclaim inherited assets.

Related Read: Tax Connections Newsletter – Winter 2023

For assistance with the above or other inheritance issues, please contact your ORBA advisor.

For more information, contact Manal Shalabi at 312.670.7444 or your ORBA advisor. Visit ORBA.com to learn more about our Wealth Management Services.