How to Identify Estate Assets That Generate Income

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1Identifying Qualified Income Generating Assets

2Calculating the Estate's Income

3Minimizing Tax Liability

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A decedent's estate (i.e., the property a person leaves behind when they die) is considered a taxable entity by the Internal Revenue Service (IRS). If a decedent's estate has assets that generate income, that income can be taxed by the IRS as estate income tax. If you are the executor of someone's estate, it is important to recognize what assets within the estate might generate income and how to deal with those assets. Generally, you will want identify income generating assets so you can complete the estate's income tax return. Before the decedent passes away, there are things he or she can also do to minimize an estate's income tax liability.

Steps

Part 1

Part 1 of 3:

Identifying Qualified Income Generating Assets

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   Search through useful IRS documents. For federal estate income tax purposes, income generating assets are defined and identified by various federal laws and IRS regulations. In order to find out what the IRS considers income generating assets, it helps to know what the purpose of this knowledge is and where you can find information on it. Start your search by visiting the IRS website and looking for documents relating to "estate income tax." The information you find will help you identify assets that may generate income for an estate. In general, an estate's income will be calculated the same way as an individual's. The most important documents you will find include:

   • IRS Form 1041, which is the actual estate income tax return. This document lists the types of income that must be included and calculated in an estate's income tax return.
   • IRS Form 1041 instructions, which provides detailed advice on filling out and completing Form 1041. Within these instructions are examples of income generating assets.
   • IRS Publication 559, which is a helpful guide for survivors, executors, and administrators of estates. Within this guidance document is a discussion about income that needs to be included in estate income tax returns.
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   Find interest income. The first type of income that must be disclosed on an estate's income tax return is interest income. Therefore, any type of property owned by the estate that generates interest will generally be considered an income generating asset. Examples of assets that generate interest income include:

   • Accounts with banks and credit unions (including certificates of deposit and money market accounts)
   • Notes, loans, and mortgages
   • U.S. Treasury bills, notes, and bonds
   • U.S. savings bonds
   • Interest earned from other assets that show up on the decedent's IRS Form 1099-INT
   • Other assets described in IRS examples
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   Include ordinary dividends. Dividends are distributions from corporations and mutual funds paid to the decedent or estate when they own stock. Ordinary dividends are those that are taxable as income (i.e., not capital gains). You can usually assume that any dividend received from common or preferred stock is an ordinary dividend.

   • If the decedent or estate receives a 1099-DIV, ordinary dividends will be shown in box 1a. A 1099-DIV is given out by every payer (i.e., corporation) that provides dividends of at least $10 in a given year.
   • The asset that generates ordinary dividend income is usually stock.
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   Identify business income. Business income is any income the decedent or their estate receives from their business. If there is any connection between the income received and the business, it is business income. A connection exists if the income payment would not have been made if you did not have the business. Business income is usually in the form of cash, checks, and credit card charges. Examples of business income include:

   • Bartering for property or services (e.g., a lawyer who gives legal services for a fee, an artist who sells a painting)
   • Real estate rents (e.g., the owner of a hotel)
   • Personal property rents (e.g., the rental of vehicles, tuxedos, televisions)
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   Recognize capital gains. Capital gain (or loss) is the difference in the value of an asset from when it was bought to when it was sold. Capital gains are assessed on any asset the estate or decedent owned and used for personal or investment purposes (e.g., homes, couches, some stocks and bonds). If the decedent or estate has capital gains, they will usually be taxed at a lower rate than ordinary income. Examples of possible capital assets include:

   • Stocks and bonds
   • A home
   • Timber
   • Household furnishings
   • A car used for pleasure or commuting
   • Coin and stamp collections
   • Gems and jewelry
   • Gold, silver, and other metals
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   Pinpoint any farm income. If the decedent or estate owns a farm, the income generated from the farm must usually be reported on the estate's income tax return. Here, the asset that generates the income is clear, it is the farm. In general, farm income usually comes from the sale of farm products (e.g., livestock and crops).
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   Find ordinary gains. Ordinary gain is income earned from the sale of an asset that is not a capital asset. The sale of non-capital assets will result in ordinary gains or losses. The IRS rules on what is considered a non-capital asset are very complex. If you are having trouble determining whether an asset is generating ordinary gains or capital gains, you should reach out to an accountant or tax professional. Common examples of non-capital assets that can generate income include:

   • Stock held mainly for sale to customers
   • Accounts receivable acquired in the ordinary course of business
   • Certain copyrights
   • Supplies normally used or consumed during the normal course of business
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Part 2

Part 2 of 3:

Calculating the Estate's Income

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   Gather the required documents. As the executor of an estate, the main purpose for identifying estate assets that generate income is so you can accurately fill out and file an estate income tax return. To accurately fill out an estate income tax return, you will first need to identify every asset the estate holds that is generating income, define the income correctly, and obtain the proper tax forms to fill out.

   • For example, if the estate has a home that was recently sold, the difference in value between when it was bought and when it was sold might be considered a capital gain. If it is a capital gain, you will need to obtain a Schedule D (Form 1041) that you can fill out and attach to the estate's income tax return. As you can see, in this example, you identified the asset (the home), you defined the income (capital gains), and you obtained the proper tax forms (Schedule D).
   • You will need to complete this process for every single asset that has produced income over the past year. At the end of this process you will have gathered all the required documents needed to accurately fill out the estate's income tax return.
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   Fill out the required documents. Starting with interest income and working your way through the various income types in IRS Form 1041, calculate the amount of income the estate has generated in the past year. Aside from using Form 1041 to see what other forms you may need, you will not fill in any spaces on Form 1041 until later. For example, by looking at Form 1041, you can see that if the estate has any business income you will need to fill out and attach Schedule C (Form 1040). In another example, if you have any farm income, you will have to fill out and attach Schedule F (Form 1040).

   • Each of these schedules will help you work through the process of determining how much income was produced from each income source. For example, if the estate has business income and you use Schedule C-EZ (Form 1040), you will calculate the business's gross receipts as well as the business's total expenses. When you subtract the total expenses from the gross receipts you are left with the business's net profit, which is the number entered on Form 1041.
   • For example, assume decedent's business has $6,000 in gross receipts and $3,000 in total expenses. When you subtract $3,000 from $6,000 you get a net profit of $3,000. This number will be entered into line 3 of Form 1041.
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   Transfer the appropriate numbers to IRS Form 1041. Once you have filled out all the required schedules, you will simply transfer the appropriate numbers from your schedules into the appropriate boxes in Form 1041. Each schedule will provide you with instructions on how to do this. For example, Schedule C-EZ (Form 1040) informs you that you should insert the number from line 3 of that schedule into line 3 of Form 1041. In another example, Schedule D (Form 1041) informs you that you should insert the number from line 19 of that schedule into line 4 of Form 1041.
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   Add up all of the estate's income. Once you complete all of the transfers, Form 1041 lines 1 through 8 should be filled in (if you have any income to report). To calculate the estate's total income you simply need to add together the numbers in lines 1 through 8. Enter this number into line 9 of Form 1041.
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Part 3

Part 3 of 3:

Minimizing Tax Liability

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   Donate assets to charity. Once the decedent passes away there is not a whole lot you can do, as the executor, to minimize the estate's income tax liability. However, while the decedent is still alive, he or she can make certain decisions to help reduce the amount of income tax their estate will have to pay when they pass away. One option is to donate income producing assets to charity before the decedent passes away. By donating the assets while the decedent is still alive, he or she will be able to take tax deductions on their personal income tax return. In addition, by removing an income producing asset from the possible estate, the decedent is minimizing the estate's income tax liability as well.

   • Assets the decedent might consider donating to charity include stocks, bonds, mutual funds, and real estate.
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   Designate individuals as beneficiaries. Before the decedent passes away, he or she should designate beneficiaries for income producing assets where beneficiary designation is possible. One common asset where this is possible is retirement accounts (i.e., IRAs). If the decedent fails to designate a beneficiary in their IRA, the IRA will be included in the estate's assets and income tax will be due on it within five years of death.

   • However, if the decedent does designate a beneficiary, the beneficiary will receive the asset outside of the probate process and the asset will not be included in the estate.
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   Create a trust. When someone creates a trust they take the trust assets and distribute them upon death outside of the probate process. When this happens, property placed in a trust is not included in the decedent's estate. Once the decedent passes away, the trust property is distributed in accordance with the terms of that trust. If the decedent places income producing assets in trust, that income will not be subject to estate income tax.
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