LONG EMBEDDED IN the federal tax code is a provision that provides important advantages for people who sell inherited stocks, real estate or other investments that have appreciated in value and are held outside retirement accounts.
In tax lingo, the basis (the starting point for measuring gain or loss) of inherited assets “steps up” from their original basis (cost, in most instances) to their date-of-death value. It’s as if the inheritors had bought the assets that day. There’s even a limited exception for executors of estates: They’re allowed to choose an alternative valuation date for inherited assets—the value six months after the date of death.
Put another way, inheritors of, say, a stock portfolio sidestep taxes on the shares’ increase in value while they were owned by the person who bequeathed them. An example: Assume that Aunt Emma left you shares of Icarus Airlines. She paid $10,000 for Icarus shares that were worth $250,000 at her death. Subsequently, you unload them for $300,000.
How does a stepped-up basis benefit you? Your basis for the shares automatically increases from $10,000 to $250,000, their market value at the date of her death. A basis of $250,000 for the shares shrinks your taxable profit to just $50,000—their increase in value between the time Emma died and the time you sell them for $300,000.
You forever escape capital gains taxes on the $240,000 increase in value between the time Emma bought the shares and the time she died. In short, the amount she paid for the shares is irrelevant.
With that kind of scenario in mind, here are some reminders for both Emma and you. Emma’s financial advisor should remind her that a stepped-up basis trims taxes. That should prompt Emma to remind the executor of her will to determine the date-of-death value of the Icarus shares. Finally, the executor should remind you—the inheritor—to avail yourself of the stepped-up basis in determining gain or loss whenever you sell the shares.
Emma and her advisor shouldn’t think that their work is done. They also ought to discuss how best to determine date-of-death values for her other holdings. Let’s say Emma owns substantial amounts of property that, unlike shares traded on exchanges, aren’t sold on a regular basis.
Such property might include shares in closely held companies, a main residence, a second home, rental property, other kinds of real estate, jewelry, artwork, antiques and other collectibles. These kinds of assets might require appraisals. Appraisals obtained at the time of Emma’s death for relatively modest amounts might avoid hefty payments later on to attorneys, accountants and other advisors to resolve disputes with federal and state tax collectors.
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator). His previous articles include Give and Receive, Hitting Home and No Touching. Information about his books is available at JulianBlockTaxExpert.com. Follow Julian on Twitter @BlockJulian.