Taxes

Q&A: Can investment gains outweigh inherited IRA penalties?

September 7, 2026 By Liz Weston Leave a Comment

Dear Liz: You recently answered a question from a person who inherited their father’s IRA in 2010 and learned they faced significant penalties for failing to withdraw the money over the subsequent 10 years.

But given how well the market has done over the last 16 years, is it possible they will end up with even more money despite the penalties than if they had withdrawn the funds as required?

Answer: No. The penalties are hefty enough that even a bull market shouldn’t tempt someone into ignoring them.

By the way, the original letter writer wasn’t required to drain the inherited IRA within 10 years.

That requirement for most nonspouse beneficiaries has only been in place since the SECURE Act of 2019. Before then, inheritors were typically allowed to stretch withdrawals over their own lifetimes — but they were still required to make annual withdrawals or face 50% penalties.

The SECURE Act reduced those penalties to a 25% excise tax on the amount that hadn’t been withdrawn. The penalty can be reduced to 10% if corrected within two years.

Q&A: Why marriage can reduce taxes on a home sale

August 3, 2026 By Liz Weston

Dear Liz: We are a heterosexual couple who are registered domestic partners in California. We have owned our primary residence for decades. Obviously, its value has increased and is well past the $500,000 home sales exemption limit for couples.

When one of us passes away, how is the basis and the appreciation of the residence calculated for federal and state taxes? Does the step-up basis come into play for both federal and state taxes when calculating capital gains? We do not have any children and are leaving the bulk of our estate to charity.

Answer: California offers the valuable double step-up in tax basis to registered domestic partners, but the federal government does not.

In most states, one half of a couple’s jointly owned property gets a new value for tax purposes when the first partner dies. This step-up in value eliminates capital gains taxes on any appreciation that happened during the deceased partner’s ownership.

In community property states, however, both halves of jointly owned property can get the step-up in value when the first spouse dies. California generally treats registered domestic partners the same as married couples, but IRS Revenue Ruling 2013-17 and Regulation 301.7701-18(c) specify that “marriage” and “spouse” do not include registered domestic partnerships for federal tax purposes, according to Wolters Kluwer Tax & Accounting.

Let’s say you bought the house for $300,000 in the 1980s, invested $100,000 in upgrades over the years and it’s worth $2 million today. The current tax basis would be $400,000 (the sales price plus the upgrades). That’s the amount the two of you would subtract from the sales price to determine the potentially taxable capital gain. You could exempt $500,000 of the home sale proceeds ($250,000 per owner) since you’ve owned and lived in the property at least two of the past five years. That leaves a taxable gain of $1.1 million.

If one of you died tomorrow, only half of the property would get stepped up to the current market value for federal tax purposes while the other half would retain its $200,000 basis for a total basis of $1.2 million. For state tax purposes, both halves would get the step-up so the new tax basis for state taxes would be $2 million.

Something else to consider: a federal law allows the full $500,000 exclusion for surviving spouses if they sell the home within two years of the death. That provision is not extended to registered domestic partners.

As you can see, a marriage certificate could make an enormous difference if the survivor wanted or needed to sell the home after the first death.

Marriage confers a number of other benefits under federal law. A spouse can receive Social Security spousal and survivor benefits, for example, but registered domestic partners aren’t eligible for benefits on a partner’s earnings record. Spouses also have special rights with IRAs and employer retirement plans, such as being able to treat an inherited IRA as their own. Non-spouse beneficiaries, including domestic partners, generally must empty the accounts within 10 years.

Your mileage may vary, but the benefits are numerous and valuable enough to make marriage worthwhile in many cases. Please talk to your tax pro and estate planning attorney for individualized advice.

Q&A: How can I withdraw money from an IRA without paying taxes?

July 21, 2026 By Liz Weston

Dear Liz: I’ve been retired for 17 years due to illness. My wife has passed away. I know nothing about finances. She did it all. I have an IRA with my wife. I want to withdraw from it but not be penalized on taxes. I know there is a way, but I don’t know the proper way.

Answer: Please find a good tax professional to help you. Retirement accounts have a lot of rules and some stiff penalties if you get things wrong. Even people who know a lot about finances can get confused and make costly mistakes. Since you’re starting from zero, you’ll definitely want expert advice to guide you.

Let’s start with the fact that withdrawals from traditional retirement accounts are typically taxable. That’s only fair, since people usually get a tax break for putting money into the account and the balances grow tax-deferred for many years. At some point, Uncle Sam wants his due. Withdrawals from IRAs usually must start by a certain age (currently 73) and are added to your taxable income. You can face penalties if you don’t make these withdrawals on time. You’ll also face penalties if you try to tap retirement accounts too early (typically before age 59½).

Roth IRAs are the exception to these rules. You don’t get a tax break on contributions to a Roth, but withdrawals in retirement are typically tax free and there’s no requirement to make withdrawals by a certain age. Also, you can withdraw the money you contributed directly to a Roth IRA at any time without facing taxes or penalties.

You mentioned that you have this account “with” your late wife, but you can’t own an IRA with another person. If you’ve inherited your wife’s IRA, the rules about when you have to start taking withdrawals can vary. Again, you’ll want to consult a tax pro who can give you individualized guidance.

Q&A: When to report an unresponsive accountant

July 6, 2026 By Liz Weston

Dear Liz: In a previous column, you answered a question from someone dealing with an unexpected bank levy by a state tax agency. The accountant who prepared the tax returns wasn’t responding to emails or calls. If an accountant ignores a client, then a complaint should be filed with the state’s board of accounting. If the accountant is licensed, the state board will likely follow up.

Answer: That’s a good suggestion. As mentioned in the previous column, many tax pros struggle to keep up with client communications during the busy tax season and may back-burner questions they don’t see as urgent. But if the ignored client still hasn’t heard back from their tax pro at this point, making a complaint to the board of accounting could be a reasonable response.

Q&A: How the kiddie tax can derail your inheritance tax strategy

July 6, 2026 By Liz Weston

Dear Liz: I’m about 50 and have two early elementary school children. I make really good money and with the combination of all taxes the last dollar I make is taxed at about 50%.

I stand to inherit about $5 million from my parents. The problem is that about $3 million of that is in retirement funds. If those funds go to me, over the next 10 years I will have to take them as income and will lose half to taxes. I’m considering asking my mother to leave $1 million to each grandchild so that they can take it as income at a much lower tax rate, possibly saving $300,000 per kid. The problem is I am not sure I want my kids to have access to a million dollars the second they turn 18.

Is there any way I can avoid either giving them a ton of money when my parents die or me paying a ton in income taxes? Both kids already have 529s that will be filled in three to five years, so that is already out.

Answer: Not only is giving a million bucks to a teenager a bad idea, but the tax savings you’re hoping for may not materialize thanks to the kiddie tax.

Basically, unearned income above $2,700 a year is taxed at the parents’ rate, not the child’s, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Unearned income includes interest, dividends, capital gains and taxable distributions from retirement accounts.

The kiddie tax can apply to offspring up to the age of 23 depending on their circumstances.

Minors who inherit a retirement account from a parent are required to take small distributions based on their own life expectancies until they turn 21. After that, they typically have to drain the accounts within 10 years. The 10-year clock starts immediately, however, when minors inherit a retirement account from anyone who is not a parent.

Another issue is that your parents’ retirement accounts don’t get the valuable step-up in tax basis at death that their taxable accounts would get, says Jennifer Sawday, an estate planning attorney in Long Beach. The step-up insures that no capital gains taxes are owed on the appreciation that occurs during the original owners’ lifetime. If your parents want to maximize the inheritance they leave, it would make sense to preserve those taxable assets as much as possible and spend down the retirement accounts, Sawday says. Another option is converting some of their retirement money to Roth IRAs, especially if their tax bracket is lower than yours and they’re willing to pay the taxes on the conversions. You’d still have to empty the Roths within 10 years of their deaths, but the withdrawals would be tax free.

Properly drafted trusts are another option to consider if your parents want to skip you and get money directly to their grandkids, Sawday says. Trusts allow distributions at specified ages (such as 25, 30 or even later). But trusts have complex rules and can have high tax rates. Your parents need to consult an experienced estate planning attorney as well as a tax pro before taking any of these actions.

Q&A: Living in your rental? The tax benefits aren’t so clear cut

June 29, 2026 By Liz Weston

Dear Liz: My husband and I have owned a rental property for 20 years. We’ve never lived in it. Now, we want to get out of the landlord business. We know we’ll have to recapture depreciation, but we always thought we could live in the property for a couple of years to save some on the capital gains taxes. Our accountant has told us that this is no longer true and we cannot save much by living in our rental. Federal and state taxes will take most of our profit. Is this true?

Answer: Congress dramatically shrank the loophole that once allowed people to reduce or eliminate capital gains on rental and vacation properties.

When selling a primary residence, homeowners can shelter up to $250,000 of home sale proceeds, or $500,000 for married couples, from capital gains tax if they’ve owned and lived in the home at least two of the previous five years. Those rules were established in the Taxpayer Relief Act of 1997.

Before the Housing Assistance Tax Act of 2008, landlords could move into their rentals for a couple of years, sell the properties and then invoke the home sale exclusion as if the property had been their primary residence all along.

Today most if not all of the gain on your property is considered “non-qualified use.” Only the appreciation you experienced before 2009, and after you move in, would qualify for the exemption.

The benefits of moving into a rental for a couple of years can vary greatly, depending on the specifics of your situation. Your tax pro can walk you through the math and advise you about some of your other tax-saving options, such as a 1031 exchange for another rental property or holding the real estate until death, when your heirs would benefit from a valuable step-up in basis. If you’re done with being a landlord, though, the cleanest solution might be to simply sell and pay the tax.