When you sell stock or another investment asset, you normally pay capital gains tax on the difference between the amount you get for selling it and what you paid for it. What you paid for it is known as the cost basis or tax basis. If you inherit stock, the tax basis is normally reset, so it's not the same as the basis before its previous owner died.
The tax basis of inherited stock is usually the stock's price on the day the previous owner died. In some cases, it may instead be the date six months after that person passed away
Determining the Cost Basis of Inherited Stock
If you're going to sell stock, you need to know its cost basis in order to figure out and pay your taxes. If the price is higher than the cost basis, you can claim a capital gain, and if it's lower than the cost basis, you can claim a capital loss.
If you inherit stock, the cost basis does not pass from the deceased person to you. Instead, the cost basis is generally automatically reset either when the deceased person passes away or, if the estate decides, six months after that date. That makes computing the cost basis much easier, since it's not necessary to look through the deceased person's historical records to figure out what he or she paid for the stock. It can also potentially save you a lot of money on the sale of the inherited stock if the stock has increased in value while the deceased person owned it.
That valuation is used both for figuring out the cost basis for when you sell the stock and for determining its value for the purpose of estate tax. Generally, the estate chooses whether to value the deceased person's assets immediately upon death or six months later.
The Alternative Valuation Date
Estates administrators generally choose whether to use the date of death cost basis or the alternative valuation date six months later.
One of the main factors impacting this choice is the effect on estate tax, which is charged by the federal government on substantial estates worth millions of dollar. Other influencing factors on the decision to use the alternative valuation date are the effects on the cost basis of stocks, bonds and other inherited investment assets. If enough securities and investments are involved, one choice or another can often make a big difference to the heirs of an estate.
Impact of 2018 Tax Law Changes
Starting in the year 2018, estates valued at or under $11,180,000 are generally exempt from federal estate tax, which means that's effectively not a consideration for the vast majority of people when a loved one passes away.
Long-term capital gains tax rates are also changing slightly, though as in previous years most taxpayers will pay a 15 percent capital gains rate, while some will fall into a 0 percent or 20 percent capital gains rate.
Tax Law in 2017
For tax year 2017, the estate tax exemption is still generous, with estates valued at $5,490,000 untaxed. Capital gains rates in 2017 correspond to ordinary income tax brackets, with rates of 0, 15 or 20 percent depending on total taxable income.
- IRS: Publication 551, Basis of Assets
- The Motley Fool: How to Calculate the Basis for Inherited Stock
- Bankrate: Do I Have to Pay Taxes on Inheritance?
- IRS: Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return
- Financial Web: Taxes on Inherited Stock
- OlsenThielen: Should You Elect the Alternate Valuation Date for Estate Tax?
- IRS: What's New - Estate and Gift Tax
- The Motley Fool: Your Guide to Capital Gains Taxes in 2018