When a family member dies, the deceased person's assets go into probate. During the process, a probate court takes account of all asset and liabilities, including stocks. If you inherit stock, your cost basis is the value of the shares while the original owner was still alive. Generally, you don't pay taxes on inherited stock.
The probate process helps transfer assets of an estate in an orderly fashion through the legal system after a person dies. A living will and testament determines how the estate transfers during probate and by whom. However, if a person dies without a will, the laws in the state where he lived specify who gets parts of his estate. The probate court makes an assessment of the assets and liabilities of the deceased and makes contact with creditors and beneficiaries.
Step-up Basis Rule
When you inherit stock as part of the probate process, the value of the stock is based on the value of the stock while the original owner was alive. This is called the "step-up basis," which means you're not on the hook for the capital gains on the stock that the owner enjoyed while she was alive. The date of death for estate purposes may differ from the actual date of the deceased. The executor of the estate may use an "alternate date of death" to reduce the estate's tax bill. The alternate date of death may be up to six months later, or if earlier, the date you were awarded the shares.
Gains and Losses
If you sell probate stock and realized a capital gain during that time, you have to pay taxes on this amount. For example, if you inherited stock worth $50,000, your cost basis is $50,000. However, if after two years, you sell the stock and it is now worth $64,000, you must pay taxes on capital gains of $14,000 ($64,000 - $50,000). If on the other hand, you sell the shares for a loss, the IRS allows you to record a capital loss. You can use this capital loss to offset any long-term gains on other stocks you own.
When you file taxes, you must report to the IRS the value of the inherited stock using Schedule D. In the space provided for the acquisition date, enter "inherited." Don't make the mistake of actually putting the day you received the stock. Incorrectly putting the date you received the stock shows a shorter holding period and may not qualify you for a lower tax rate.
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