you sell them, the same as the decedent would have done if he had lived to sell them himself.

So, now let's relate all this to your specific questions. First, if you cash in the bonds, you won't have to pay any capital gains taxes because there won't be any capital appreciation in the value of the bonds. Bonds are nothing more than an I.O.U. In this case, your grandmother loaned money to the federal government and the federal government agreed to pay her interest for the use of her money. When the I.O.U. (i.e., the bond) is redeemed, you'll be paid back the amount your grandmother loaned to the federal government, plus the interest earned on the loan. The interest is ordinary income (IRD) and is taxable to whomever owns the bond at the time it is redeemed.

Because HH bonds pay interest semi-annually, there probably won't be much accrued interest that you'll receive when the bonds are redeemed. However, whatever interest is accrued at that time will be paid to the holder and it will be taxed to the holder as ordinary income in the year the bonds are redeemed.

One final point. Distributions from an estate (or trust) are deemed to carry out ordinary income first and principal second. For this reason, it is generally advisable to have the estate

Question: My grandmother, recently deceased, left E, EE, & HH bonds to me, my sister, and mother. The total is approximately $600,000, under the limit to be taxed. However, there is substantial interest accrued on the bonds. What would be the best way to distribute these? Should we have them changed to our names to avoid the Capital Gains or do the taxes have to be paid before distributed? Will taxes be due when we eventually cash them in? Will any taxes be due on the HH bonds? Are the CGT over and above the income taxes? Please Advise. Thank You. R.

Answer: Dear R - First, you indicated that the bonds have a value of approximately $600,000 and you say that this is "under the limit to be taxed." If you're referring to the federal estate tax, I would agree - as long as the combined value of all your grandmother's assets do not exceed $2 million, you don't have to worry about federal estate taxes.

From an income tax standpoint, however, you are correct in thinking that the bonds may be subject to tax if they are cashed in. Let's go over the tax rules on this and see where we stand with respect to these bonds.

Most of us are aware of the "step-up in basis" rules that apply upon death. Those rules, however, only apply to capital assets. For example, if you buy a house for $100,000 and you sell it for $250,000, you have a capital gain of $150,000, which you report on Schedule D of your Form 1040 in the year of sale. The gain is the difference between your sale price ($250,000) and your cost basis ($100,000). Your cost basis is what you paid for the house, plus any capital improvements you make during the time you own it. Keep in mind that you only pay a tax on the increase in the value of your capital (i.e., a capital gain) - and you only pay the tax when the capital asset is sold or otherwise disposed of.

The tax laws give you a break if you hold a capital asset until death. In that case your "cost basis" is increased to its date of death value. The practical effect of this rule is to eliminate any capital gains tax on the appreciation of your capital assets from the time you acquired them until the time you die. When your heirs take over your capital assets, they start off with a cost basis equal to the date of death value.

In the above example, if you own the house until you die and the date of death value is $250,000, then the $150,000 unrealized capital gain is forgiven entirely. Your heirs then take over the house with a cost basis of $250,000. If they later sell the house, their capital gain would be the difference between the selling price and their cost basis of $250,000.

The step-up in basis rule, as we've just discussed, only applies to the increase in value of your capital assets - it doesn't apply to the income earned by your capital assets. In tax parlance, the increase in value of your capital assets is called a "capital gain." The income earned by your capital assets is called "ordinary income." The most common types of ordinary income are interest and dividends.

One way to distinguish a capital gain from ordinary income is through the use of the apple tree analogy. If you buy an apple tree and it increases in value over the years, that increase in value is treated as a capital gain. The gain is "unrealized" until you sell the tree. When you do sell or otherwise dispose of the tree, you then "realize" the gain and you pay a tax on the capital gain at that time.

If you hold the tree until you die, the unrealized gain is forgiven and your heirs take the apple tree at its value upon your death. This is the benefit of the step-up in basis rule.

Now let's take a look at the apples growing on the tree. They represent the earnings on your investment, which are taxed as ordinary income. The apples are very much like dividends and interest that is earned on stocks and bonds; i.e., they all represent the earnings on your investment.

Most ordinary income is taxed in the year it is earned. However, with bonds, the interest earned each year is allowed to accrue untaxed until the bond is sold or cashed in - very much like the apples on our apple tree. When you eventually do liquidate a bond, the money you receive actually represents two things: a return of your capital investment (cost basis), plus accrued interest. In some cases, if you sell a bond rather than redeem it, you may receive a premium over the face value. In that case, the premium represents an appreciation in the value of your capital investment; i.e., a capital gain.

While the appreciation in the value of your capital investments (i.e., capital gain) is forgiven upon death by virtue of the step-up in basis, the same is not true for the earnings on your capital investments; i.e., ordinary income. This type of income is referred to as "income in respect of a decedent" or "IRD" for short.

Think of it this way - if you inherit an apple tree with the apples on it, you won't pay a capital gain on the appreciation in value up to the time of the decedent's death, but you'll pay taxes on the apples when you sell them, the same as the decedent would have done if he had lived to sell them himself.

So, now let's relate all this to your specific questions. First, if you cash in the bonds, you won't have to pay any capital gains taxes because there won't be any capital appreciation in the value of the bonds. Bonds are nothing more than an I.O.U. In this case, your grandmother loaned money to the federal government and the federal government agreed to pay her interest for the use of her money. When the I.O.U. (i.e., the bond) is redeemed, you'll be paid back the amount your grandmother loaned to the federal government, plus the interest earned on the loan. The interest is ordinary income (IRD) and is taxable to whomever owns the bond at the time it is redeemed.

Because HH bonds pay interest semi-annually, there probably won't be much accrued interest that you'll receive when the bonds are redeemed. However, whatever interest is accrued at that time will be paid to the holder and it will be taxed to the holder as ordinary income in the year the bonds are redeemed.

One final point. Distributions from an estate (or trust) are deemed to carry out ordinary income first and principal second. For this reason, it is generally advisable to have the estate r

le, if you buy a house for $100,000 and you sell it for $250,000, you have a capital gain of $150,000, which you report on Schedule D of your Form 1040 in the year of sale. The gain is the difference between your sale price ($250,000) and your cost basis ($100,000). Your cost basis is what you paid for the house, plus any capital improvements you make during the time you own it. Keep in mind that you only pay a tax on the increase in the value of your capital (i.e., a capital gain) - and you only pay the tax when the capital asset is sold or otherwise disposed of.

The tax laws give you a break if you hold a capital asset until death. In that case your "cost basis" is increased to its date of death value. The practical effect of this rule is to eliminate any capital gains tax on the appreciation of your capital assets from the time you acquired them until the time you die. When your heirs take over your capital assets, they start off with a cost basis equal to the date of death value.

In the above example, if you own the house until you die and the date of death value is $250,000, then the $150,000 unrealized capital gain is forgiven entirely. Your heirs then take over the house with a cost basis of $250,000. If they later sell the house, their capital gain would be the difference between the selling price and their cost basis of $250,000.

The step-up in basis rule, as we've just discussed, only applies to the increase in value of your capital assets - it doesn't apply to the income earned by your capital assets. In tax parlance, the increase in value of your capital assets is called a "capital gain." The income earned by your capital assets is called "ordinary income." The most common types of ordinary income are interest and dividends.

One way to distinguish a capital gain from ordinary income is through the use of the apple tree analogy. If you buy an apple tree and it increases in value over the years, that increase in value is treated as a capital gain. The gain is "unrealized" until you sell the tree. When you do sell or otherwise dispose of the tree, you then "realize" the gain and you pay a tax on the capital gain at that time.

If you hold the tree until you die, the unrealized gain is forgiven and your heirs take the apple tree at its value upon your death. This is the benefit of the step-up in basis rule.

Now let's take a look at the apples growing on the tree. They represent the earnings on your investment, which are taxed as ordinary income. The apples are very much like dividends and interest that is earned on stocks and bonds; i.e., they all represent the earnings on your investment.

Most ordinary income is taxed in the year it is earned. However, with bonds, the interest earned each year is allowed to accrue untaxed until the bond is sold or cashed in - very much like the apples on our apple tree. When you eventually do liquidate a bond, the money you receive actually represents two things: a return of your capital investment (cost basis), plus accrued interest. In some cases, if you sell a bond rather than redeem it, you may receive a premium over the face value. In that case, the premium represents an appreciation in the value of your capital investment; i.e., a capital gain.

While the appreciation in the value of your capital investments (i.e., capital gain) is forgiven upon death by virtue of the step-up in basis, the same is not true for the earnings on your capital investments; i.e., ordinary income. This type of income is referred to as "income in respect of a decedent" or "IRD" for short.

Think of it this way - if you inherit an apple tree with the apples on it, you won't pay a capital gain on the appreciation in value up to the time of the decedent's death, but you'll pay taxes on the apples when you sell them, the same as the decedent would have done if he had lived to sell them himself.

So, now let's relate all this to your specific questions. First, if you cash in the bonds, you won't have to pay any capital gains taxes because there won't be any capital appreciation in the value of the bonds. Bonds are nothing more than an I.O.U. In this case, your grandmother loaned money to the federal government and the federal government agreed to pay her interest for the use of her money. When the I.O.U. (i.e., the bond) is redeemed, you'll be paid back the amount your grandmother loaned to the federal government, plus the interest earned on the loan. The interest is ordinary income (IRD) and is taxable to whomever owns the bond at the time it is redeemed.

Because HH bonds pay interest semi-annually, there probably won't be much accrued interest that you'll receive when the bonds are redeemed. However, whatever interest is accrued at that time will be paid to the holder and it will be taxed to the holder as ordinary income in the year the bonds are redeemed.

One final point. Distributions from an estate (or trust) are deemed to carry out ordinary income first and principal second. For this reason, it is generally advisable to have the estate

al gain would be the difference between the selling price and their cost basis of $250,000.

The step-up in basis rule, as we've just discussed, only applies to the increase in value of your capital assets - it doesn't apply to the income earned by your capital assets. In tax parlance, the increase in value of your capital assets is called a "capital gain." The income earned by your capital assets is called "ordinary income." The most common types of ordinary income are interest and dividends.

One way to distinguish a capital gain from ordinary income is through the use of the apple tree analogy. If you buy an apple tree and it increases in value over the years, that increase in value is treated as a capital gain. The gain is "unrealized" until you sell the tree. When you do sell or otherwise dispose of the tree, you then "realize" the gain and you pay a tax on the capital gain at that time.

If you hold the tree until you die, the unrealized gain is forgiven and your heirs take the apple tree at its value upon your death. This is the benefit of the step-up in basis rule.

Now let's take a look at the apples growing on the tree. They represent the earnings on your investment, which are taxed as ordinary income. The apples are very much like dividends and interest that is earned on stocks and bonds; i.e., they all represent the earnings on your investment.

Most ordinary income is taxed in the year it is earned. However, with bonds, the interest earned each year is allowed to accrue untaxed until the bond is sold or cashed in - very much like the apples on our apple tree. When you eventually do liquidate a bond, the money you receive actually represents two things: a return of your capital investment (cost basis), plus accrued interest. In some cases, if you sell a bond rather than redeem it, you may receive a premium over the face value. In that case, the premium represents an appreciation in the value of your capital investment; i.e., a capital gain.

While the appreciation in the value of your capital investments (i.e., capital gain) is forgiven upon death by virtue of the step-up in basis, the same is not true for the earnings on your capital investments; i.e., ordinary income. This type of income is referred to as "income in respect of a decedent" or "IRD" for short.

Think of it this way - if you inherit an apple tree with the apples on it, you won't pay a capital gain on the appreciation in value up to the time of the decedent's death, but you'll pay taxes on the apples when you sell them, the same as the decedent would have done if he had lived to sell them himself.

So, now let's relate all this to your specific questions. First, if you cash in the bonds, you won't have to pay any capital gains taxes because there won't be any capital appreciation in the value of the bonds. Bonds are nothing more than an I.O.U. In this case, your grandmother loaned money to the federal government and the federal government agreed to pay her interest for the use of her money. When the I.O.U. (i.e., the bond) is redeemed, you'll be paid back the amount your grandmother loaned to the federal government, plus the interest earned on the loan. The interest is ordinary income (IRD) and is taxable to whomever owns the bond at the time it is redeemed.

Because HH bonds pay interest semi-annually, there probably won't be much accrued interest that you'll receive when the bonds are redeemed. However, whatever interest is accrued at that time will be paid to the holder and it will be taxed to the holder as ordinary income in the year the bonds are redeemed.

One final point. Distributions from an estate (or trust) are deemed to carry out ordinary income first and principal second. For this reason, it is generally advisable to have the estate

dividends and interest that is earned on stocks and bonds; i.e., they all represent the earnings on your investment.

Most ordinary income is taxed in the year it is earned. However, with bonds, the interest earned each year is allowed to accrue untaxed until the bond is sold or cashed in - very much like the apples on our apple tree. When you eventually do liquidate a bond, the money you receive actually represents two things: a return of your capital investment (cost basis), plus accrued interest. In some cases, if you sell a bond rather than redeem it, you may receive a premium over the face value. In that case, the premium represents an appreciation in the value of your capital investment; i.e., a capital gain.

While the appreciation in the value of your capital investments (i.e., capital gain) is forgiven upon death by virtue of the step-up in basis, the same is not true for the earnings on your capital investments; i.e., ordinary income. This type of income is referred to as "income in respect of a decedent" or "IRD" for short.

Think of it this way - if you inherit an apple tree with the apples on it, you won't pay a capital gain on the appreciation in value up to the time of the decedent's death, but you'll pay taxes on the apples when you sell them, the same as the decedent would have done if he had lived to sell them himself.

So, now let's relate all this to your specific questions. First, if you cash in the bonds, you won't have to pay any capital gains taxes because there won't be any capital appreciation in the value of the bonds. Bonds are nothing more than an I.O.U. In this case, your grandmother loaned money to the federal government and the federal government agreed to pay her interest for the use of her money. When the I.O.U. (i.e., the bond) is redeemed, you'll be paid back the amount your grandmother loaned to the federal government, plus the interest earned on the loan. The interest is ordinary income (IRD) and is taxable to whomever owns the bond at the time it is redeemed.

Because HH bonds pay interest semi-annually, there probably won't be much accrued interest that you'll receive when the bonds are redeemed. However, whatever interest is accrued at that time will be paid to the holder and it will be taxed to the holder as ordinary income in the year the bonds are redeemed.

One final point. Distributions from an estate (or trust) are deemed to carry out ordinary income first and principal second. For this reason, it is generally advisable to have the estate

you sell them, the same as the decedent would have done if he had lived to sell them himself.

So, now let's relate all this to your specific questions. First, if you cash in the bonds, you won't have to pay any capital gains taxes because there won't be any capital appreciation in the value of the bonds. Bonds are nothing more than an I.O.U. In this case, your grandmother loaned money to the federal government and the federal government agreed to pay her interest for the use of her money. When the I.O.U. (i.e., the bond) is redeemed, you'll be paid back the amount your grandmother loaned to the federal government, plus the interest earned on the loan. The interest is ordinary income (IRD) and is taxable to whomever owns the bond at the time it is redeemed.

Because HH bonds pay interest semi-annually, there probably won't be much accrued interest that you'll receive when the bonds are redeemed. However, whatever interest is accrued at that time will be paid to the holder and it will be taxed to the holder as ordinary income in the year the bonds are redeemed.

One final point. Distributions from an estate (or trust) are deemed to carry out ordinary income first and principal second. For this reason, it is generally advisable to have the estate redeem the bonds and then distribute the money to the beneficiaries rather than distributing the bonds directly to the beneficiaries. If you distribute the bonds directly to the beneficiaries (which is generally done on the basis of face value), each beneficiary will pay income taxes on the interest accrued on their respective bonds. Since some bonds may have more accrued interest than others and, since each beneficiary may be in a different tax bracket, they will probably pay different amounts of taxes on the bonds they receive. So, even though they all receive the same face value, the actual cash remaining after taxes will be different for each beneficiary. For this reason, you may want to have the estate redeem the bonds and distribute the cash equally to each beneficiary.