Can a Loss be Taken on an Inherited Trust of Mutual Funds?
In some circumstancesm you can sell inherited mutual funds and write off the loss on your tax return. An Internal Revenue Service provision, the "alternate valuation date," provides a special advantage to some recipients of funds held in a trust and sold at a loss. The IRS provides another advantage with respect to the requirements for long-term capital gain sales of inherited shares.
Basis of Mutual Fund Value
When someone dies, the decedent's assets are stepped up to their valuation on the date of death. For example, several years before she died, your aunt bought 1,000 shares of a mutual fund at $34 per share, which remained their cost basis until she died. When she died, the stepped-up cost basis became $70 per share. If you inherit these funds directly and sell them at $70 per share, you owe no tax. Similarly, if your aunt leaves the shares to a trust, the trust receives the funds at their stepped-up value. The trust owes no taxes on the funds, and, if the trust passes the shares on to you and you sell them, you owe no taxes on them either unless they have increased in value since your aunt's death.
If the mutual funds remain in the trust and subsequently lose value, this is an unrealized loss; the fund cannot declare a loss on the shares until they are sold. Likewise, if the trust passes the shares to you, you cannot declare a loss on the shares until you sell them. Unless you are a professional equities trader according to the IRS' strict qualifications detailed in IRS Publication 550, you can only take $3,000 in losses each year. If your losses on sales are greater than $3,000, you carry the excess over to following years, $3,000 per year, until you have taken the entire loss.
Long-Term Capital Gain or Loss
Generally, to qualify as a long-term capital gain or loss, you must hold the shares for a minimum of one year from the date of acquisition before selling them. Sales of inherited mutual funds are an exception and are considered long-term gains or losses no matter when you sell them. If the equities gained value from the date of your aunt's death, the gain is subject to the lower long-term capital gains rate, which varies according to your own income. You calculate and report capital gains and losses on Schedule D, "Capital Gains and Losses," then transfer the result to line 13 of IRS Form 1040.
Alternate Valuation Date
Generally, the cost basis of equities is their value on the date of death. An exception is the alternate valuation date, which is available if using it decreases both the overall value of the estate and the estate tax liability. In that case, the mutual funds in the trust are valued on the date of sale within a six-month window following your aunt's death. This only applies if the estate is large enough to be subject to the estate tax, which for 2013 is a minimum of $5,250,000. If your aunt's estate is smaller than that, the valuation date is the date of your aunt's death.
I am a retired Registered Investment Advisor with 12 years experience as head of an investment management firm. I also have a Ph.D. in English and have written more than 4,000 articles for regional and national publications.