Figuring out the value of inherited stock is necessary for tax purposes. The value is called your cost basis. Normally cost basis is the amount of money you invest, which is the amount you subtract from sale proceeds to calculate your gain or loss. When you inherit stock, you don’t have an investment, so the cost basis is determined differently.
For inherited stock, the original owner's cost basis is normally adjusted to the value of the shares on the date of death. If the value has increased, this is referred to as stepping up the cost basis. If the value of the inherited stock has gone down since it was purchased, the cost basis is stepped down to the price on the date of death. The Internal Revenue Service forgives any tax liability on gains before the date of death. However, any losses that occurred while the original owner was alive may not be used as a tax deduction by the heir. Stock you inherit will probably change in value after you become the owner. Any such gains or losses are always long-term for tax purposes, regardless of how long you or the original owner held the shares.
When an estate is large enough to be subject to estate taxes, the executor of the estate may be able to select an alternative valuation date. This special rule applies if the value of the inherited stock goes down after the date of death. In this situation, the executor may substitute the value of the inherited stock on the date six months later. This lowers the valuation of the stock and so reduces estate taxes.
If a surviving spouse inherits stock, it is assumed the spouses shared ownership equally. Therefore, one-half of the original cost basis is stepped up or down to the value of the shares on the date of death. The value of inherited stock by surviving spouses may be handled differently in states with community property laws. In this case, the entire cost basis is stepped up or down.
When you inherit stock because you owned the shares jointly with someone other than your spouse, the proportion of the cost basis that is attributable to the decedent’s investment is stepped up or down to the value on the date of death. For example, if the decedent contributed 40 percent of the original investment, 40 percent of the cost basis is stepped up or down. However, if it is not possible to determine how much the decedent contributed, you may assume he contributed 100 percent of the original investment and step the entire cost basis up or down.
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