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Winning the Lottery: Dream or Nightmare?

Winning the Lottery: Dream or Nightmare?

Investopedia   Thu, June 1, 2023  By THE INVESTOPEDIA TEAM

 Reviewed by PAMELA RODRIGUEZ  Fact checked by PETE RATHBURN

A house. A vacation. A thousand dollars a day for life. Who wouldn't want to win a huge prize? Actually, a lot of people—once they realize these jackpots aren't free because most prize winnings are taxed as income by the Internal Revenue Service (IRS).  And what happens when you win the lottery? Taxes and financial missteps can quickly turn some windfalls into major burdens.

Before we lay out details of the lottery win process, here are some common prizes that perhaps we've all dreamed of winning and the often overlooked costs to keep them.

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KEY TAKEAWAYS

You are taxed on anything you win, whether it's cash, an item, a trip, or a service.

Winnings are subject to federal and state income taxes.

Most tangible prizes like cars and homes are taxed at their fair market value.

Lottery winnings are taxed for the year in which they are collected, allowing winners who choose annuities to spread out the tax bill.

If you win a house, boat, or car, prepare to pay for their upkeep.

The Cost of Winning a House

After winning a home, you'll be responsible for paying the federal income tax based on the home's value. You may also be liable for state income tax, depending on your state of residence. As with any prize, the home's fair market value must be reported on Form 1040 as other income, and will be taxed at your marginal income tax rate.

Unless they already own a home that they plan to sell, many people couldn't afford to pay such a significant tax sum all at once, even with several months' notice. Furthermore, consider that homes given away as prizes are worth more than $500,000 and located in expensive areas.

Of course, if you could afford the tax bill, you'd be getting a home for the price of a generous down payment. But your costs wouldn't end there. On top of income taxes, you would also have higher recurring expenses such as property taxes, homeowner's insurance, and utility bills, not to mention the cost of general maintenance and upkeep. Despite striking it rich in the sweepstakes, you could end up house poor in the end.

 You must report any and all of your winnings to the IRS regardless of their value.

A Brand New Car

Just as with that prize of a home, you'll be responsible for federal and state income taxes on any cars that you win. These amounts will be based on the vehicle's fair market value and the combined federal and state bill might add up to about one-third of the car's value.

This may not be so bad if you win a $15,000 Ford Fiesta—you get a brand new car by paying $5,000 to the IRS. But if you win a sports car that retails for over $100,000, the tax bill would be proportionately higher. Since the cars that are given away as prizes are often luxury models, the new wheels could boost your reported taxable income quite a bit, maybe even into a new bracket taxed at a higher marginal rate.

Don't forget that you'll have to pay registration and licensing fees in order to get that car on the road. Then there are the ongoing costs associated with auto ownership. You can bet that costs for insurance premiums and maintenance are higher for a more expensive car. Oil changes on the cheapest Ferrari are pricey. And your shiny new 500-horsepower bullet probably doesn't get gas mileage that could rival your previous ride's.

A Vacation

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