Is It Smart to Turn Stocks Into Cash to Avoid Estate Tax?

The IRS taxes the total value of your estate. The types of assets don't matter.

The IRS taxes the total value of your estate. The types of assets don't matter.

When you die, the IRS could charge the estate tax on your assets before your heirs receive anything. Some planning ahead of time can help reduce this future bill. One possible move is to sell your stocks and turn them into cash. Whether this is a good tax move depends on a few factors.

Estate Tax

Whether you will owe estate taxes depends on how much property you own at the time of death. As of 2013, you can transfer up to $5.12 million of property and not owe taxes. Anything over this limit gets hit with the 40 percent estate tax rate. Estate taxes are only based on the value of the estate. The types of assets in your estate don't matter. As a result, the move of swapping $1 million of stocks for $1 million of cash alone won't reduce your taxes.

Step Up in Basis

If your stocks have gone up in value, selling them right before you die is generally a tax mistake. When you sell a stock, you get the stock basis back tax-free. While you are alive, the basis is the money you paid to buy the stock. When you die, the basis of your stocks get set to their current market price. As a result, your heirs won't owe income tax on your stock gains. If you sold these stocks yourself, you would need to pay taxes on your investment gains.

Give Away Stocks

If your stocks are gaining value each year, you can reduce your future estate taxes by giving the stocks away. You can give to as many people as you choose $14,000 a year no gift tax consequences. If you give away more to any one person, the excess counts against your $5.12 million lifetime transfer exemption. If you go over that aggregate limit, your gifts are charged the 40 percent gift tax. However, giving away stocks today before they grow in value means you are transferring less property than you would at death and therefore owing less taxes.

Stock Losses

One situation where it makes sense to sell your stocks is when they have lost money. When you sell a stock for a loss, you get a tax deduction for the capital loss. This tax deduction disappears after you die; basically the stocks step down in basis to their market value when you die. As a result, if your stocks have lost money, it would make sense to convert them to cash. This wouldn't reduce your estate taxes, but it would reduce your current income taxes.


About the Author

Dylan Armstrong specializes in insurance, investing and retirement planning. He has also worked as a life and health insurance salesman and holds a Bachelor of Science in finance from Boston College.

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