Few people want to receive a windfall through the death of a loved one, but if you inherit stocks, you’ll need to understand how your inheritance affects your tax situation. You won’t need to jump into the process right away, however, as you’ll only need to determine the stock’s basis when you get around to selling it: As with all taxes on capital gains, you’ll only need to calculate your gains when you liquidate the asset and make a sale.
Traditionally, a stock’s basis is the price at which its owner purchased it. What happens when you inherit Aunt Irma’s blue-chip stock she purchased in 1956? Are you liable for decades of gains between the date she purchased it and when you sold it? Luckily, the Internal Revenue Service doesn’t hold you accountable for the years before you owned the stock. Instead, it applies a concept called stepped-up basis to inherited stocks, essentially resetting the stock’s basis as its value when its previous owner died.
Calculating the Stepped-Up Basis
To determine the stepped-up basis for the stock, you merely need to reference historical stock data for the day its prior owner died. In some cases, the executor of the estate chooses an alternate-value date up to six months after the deceased’s death; if this is the case, use this date to determine the stock’s basis. Merely average the high and low cost of the stock on the valuation day, multiply that by the number of shares you inherited, and you have your basis.
Gain Rates on Inherited Stocks
The tax man is also pretty generous toward heirs in regard to the tax rate he applies to your gains on inherited taxes. Regardless of when you received your inheritance or when the original owner purchased the stocks, you’ll qualify for the highest long-term capital-gains rates when you sell the inherited assets. For the 2012 tax year, that’s a 15-percent tax on your gains -- not the entire proceeds of the sale -- no matter when you sell the stocks.
Losses on Inherited Stocks
After you determine the basis for your inherited stocks, the IRS treats them as any other asset in your portfolio with the exception of the automatic long-term gains rate. Because of this, you can claim a capital loss if the value of the stock declined after Aunt Irma died. As with other capital losses, these can’t directly work as a deduction. They may only be paired against gains to reduce your overall taxable profits for the year. If your losses exceed gains, you can "carry over" losses into future tax years to defray gains in those years.
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