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
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 dollars. 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.
Tax Law in 2019
For the 2019 tax year, estates valued at or under $11.4 million are generally exempt from federal estate tax (up from $11.18 million for tax year 2018), 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.
- IRS: Publication 551 (12/2018), 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
- Forbes: IRS Announces Higher 2019 Estate and Gift Tax Limits
Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.