What Are the Tax Implications of a Transfer on Death?
While a Transfer on Death avoids probate, tax obligations remain. Learn how an asset's value at death impacts what a beneficiary owes when they eventually sell.
A Transfer on Death (TOD) designation is a method for passing assets like bank accounts, brokerage accounts, and real estate to beneficiaries outside of probate. Upon the owner’s death, the asset automatically transfers to the named beneficiary, avoiding the potential delays and costs associated with probate court. While this streamlines the transfer process, a TOD does not eliminate all potential tax consequences. The transfer may still be subject to federal and state taxes, determined by the asset’s value and the size of the overall estate.
Estate and Inheritance Tax Considerations
A common misconception is that avoiding probate also avoids taxes. For tax purposes, assets transferred via a TOD are still considered part of the decedent’s gross estate. Their value is aggregated with all other property to determine if any estate taxes are due, calculated using the fair market value on the date of death.
The federal government imposes an estate tax, but only on estates that exceed a very high exemption amount. For 2025, this amount is $13.99 million per individual. Consequently, the vast majority of estates do not owe any federal estate tax. For married couples, this exemption is portable, meaning a surviving spouse can use any of their deceased spouse’s unused exemption.
A more frequent concern is state-level taxation. Twelve states and the District of Columbia levy their own estate tax, often with much lower exemption thresholds than the federal government. This makes it more likely that an estate, with TOD assets included, could be subject to state estate tax. This tax is paid by the estate itself before assets are distributed.
A few states impose a different type of tax called an inheritance tax. Unlike an estate tax, which is paid by the estate, an inheritance tax is paid by the beneficiaries who receive the assets. The tax rate often depends on the beneficiary’s relationship to the decedent. Spouses are fully exempt, and close relatives pay a lower rate than more distant relatives or friends.
Beneficiary Income Tax and Cost Basis Rules
When a beneficiary receives an asset through a Transfer on Death designation, a primary tax consideration is capital gains tax, which applies when the asset is eventually sold. The concept of “cost basis” is used to calculate the taxable gain. The cost basis is the original price the owner paid for an asset.
A tax provision known as the “step-up in basis” applies to inherited assets, including those transferred via a TOD. Under this rule, the beneficiary’s cost basis is adjusted from the original purchase price to the fair market value (FMV) of the asset on the date of the original owner’s death. This re-evaluation effectively erases the capital gain that accumulated during the decedent’s lifetime.
To illustrate, consider an investor who purchased stock for $10,000. At the time of the investor’s death, the shares are worth $50,000 and are transferred to a beneficiary through a TOD account. The beneficiary’s cost basis is “stepped up” from the original $10,000 to the $50,000 FMV at the date of death.
If the beneficiary decides to sell the stock immediately for its market value of $50,000, there is no taxable capital gain. If the beneficiary holds onto the stock and sells it two years later for $55,000, they would only owe capital gains tax on the $5,000 of appreciation that occurred after they inherited the asset, not on the $45,000 of growth during the original owner’s life.
This rule can also work in reverse. If an asset has decreased in value since its original purchase, its basis is “stepped down” to the lower FMV at the time of death. For example, if stock purchased for $10,000 was only worth $7,000 at death, the beneficiary’s basis would be $7,000.
Tax Reporting for Beneficiaries
When a beneficiary who has received an asset through a TOD decides to sell it, they must report the transaction to the IRS. This reporting is done in the tax year the sale occurs. The process involves specific tax forms designed to calculate and report capital gains or losses.
After selling an inherited asset, the financial institution that held the account will issue a Form 1099-B to the beneficiary. This form reports the gross proceeds from the sale. However, the cost basis reported on the 1099-B may be inaccurate; it might show the original owner’s cost basis or be listed as unknown.
The beneficiary uses the information from the 1099-B to complete Form 8949, “Sales and Other Dispositions of Capital Assets.” On this form, the beneficiary must list the details of the sale, including the description of the asset, the date sold, and the sales price. For the acquisition date of an inherited asset, the beneficiary should write “inherited” in the appropriate column, which automatically classifies any gain or loss as long-term.
The beneficiary must correctly report the cost basis in column (e) of Form 8949. This is the stepped-up basis, which is the fair market value of the asset on the date the original owner died. If the basis on the 1099-B is incorrect, the beneficiary will need to enter an adjustment code on Form 8949 to correct it, ensuring the calculated gain or loss is accurate. The totals from Form 8949 are then carried over to Schedule D, “Capital Gains and Losses,” and filed with the beneficiary’s tax return.