The capital gains tax is a levy on the gain, or increase, in the value of a capital asset over its basis. Capital assets include real estate, business property and equipment, jewelry, antiques, stocks, bonds, mutual funds, mineral rights, royalties, and some intellectual property like patents. The value is the amount that you sell it for or can sell it for, while the basis is the amount you paid, plus acquisition and improvement costs.
The gain is considered either short or long-term, and the tax treatment differs. Note that capital losses are also short or long-term. However, losses usually don't generate as much interest, although it's essential to keep them in mind to offset capital gains where possible. A short-term capital gain is an increase in the value of a stock or other capital asset the investor has owned for less than a year. In contrast, a long-term capital gain results from the disposition of assets held for a year or more.
Short-term gains are taxed like ordinary income—that means income from wages, salary, or self-employment. Those rates range from 10 percent to 37 percent and are progressive, so taxpayers pay the lower rate on income up to the threshold amount. Long-term gains are subject to lower capital gains tax rates, as low as zero percent and as high as 20 percent.
When do I pay taxes on the capital gain?
Taxes are incurred when you sell a stock or other equity or fund. For example, let's say that you buy 100 shares of XYZ stock at $10 per share, and nine months later, you decide to sell it because the value has increased to $25 per share. The gain you have made on that sale is $1,500 and is a short-term gain, meaning that you will pay taxes at your ordinary income rate. However, if you hold the stock for more than a year, you would have a long-term capital gain, and your tax rate would likely be lower.
What about a stock that I inherit?
Suppose your favorite uncle bought those 100 shares of XYZ stock for $10 each a long time ago and never sold them. Instead, he bequeaths them to you in his will. Once you learn of his generosity, you are shocked that the stock is now valued at $20,000 per share, nearly two million dollars. If you were to owe a capital gains tax, you would likely have to sell your valuable stock to pay the amount due. But you inherit the stock at its current value, regardless of the original basis. This scenario is called a step-up basis, which applies to many inherited capital assets. You can hold the stock (any value increases after you inherit it will result in capital gains) or sell it at the stepped-up value without owing capital gains taxes.
It's important to note that stock held in a retirement account doesn’t receive a step-up valuation. The same applies to money market funds, pensions, and tax-deferred annuities. These financial instruments have other tax advantages, however.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Examples are hypothetical and for illustrative purposes only. Withdrawal strategies should take into account the investment objectives, financial situation and particular needs of the individual.
FAQs
The person inheriting the stock only owes taxes on the change in stock price between when it was inherited and when it was sold. These taxes are charged at the long-term capital gains rate.
Do I pay capital gains on inherited stocks? ›
Inherited stock doesn't incur capital gains on any growth prior to your inheritance, but any change in value thereafter will likely trigger capital gains taxes when sold.
Do I pay capital gains on shares I inherited? ›
Generally, capital gains tax (CGT) does not apply when you inherit an asset. When you sell an asset you have inherited, and the asset is: not a property, the normal rules apply for calculating your CGT. a property, such as a house, it may qualify for the main residence exemption from CGT.
What is the inherited capital gains tax loophole? ›
The trust fund loophole lets you transfer assets to your heirs without paying the capital gains tax. High-income earners pay the highest capital gains tax rate. So, the loophole benefits them most.
What is the 6 month rule for inherited stock? ›
If the executor files an estate tax return, they could use an alternate valuation date of up to 6 months from the date of death. When you sell an inherited asset for more than the stepped-up cost basis, it would be counted as a long-term capital gain for tax purposes.
How do I avoid capital gains tax on inheritance? ›
How to Avoid Paying Capital Gains Tax on Inheritance
- Sell the inherited property quickly. ...
- Make the inherited property your primary residence. ...
- Rent the inherited property. ...
- Disclaim the inherited property. ...
- Deduct selling expenses from capital gains.
With stock options, taxes are owed when the options are exercised. ISOs: If you've inherited ISOs, they will be taxed when you choose to exercise them, but at the alternative minimum tax (AMT) rate. When you sell them, you'll be taxed again, but at your regular income tax rate.
How are capital gains calculated on inherited stocks? ›
However, if you inherited the stock due to the death of a parent, the securities typically receive a “step up in basis.” That means your capital gain or loss will be based on the fair market value at the time of death, not the time of original purchase.
How long do you need to hold a stock to avoid capital gains tax? ›
You may have to pay capital gains tax on stocks sold for a profit. Any profit you make from selling a stock is taxable at either 0%, 15% or 20% if you held the shares for more than a year. If you held the shares for a year or less, you'll be taxed at your ordinary tax rate.
What is the holding period for inherited stock? ›
Inheritances — Your holding period is automatically considered to be more than one year. So, when you sell the inherited stock, it's subject to long-term capital treatment. This applies regardless of the actual holding period.
This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due.
Do heirs have to pay capital gains tax? ›
When you inherit property, the IRS applies what is known as a stepped-up cost basis. You do not automatically pay taxes on any property that you inherit. If you sell, you owe capital gains taxes only on any gains that the asset made since you inherited it.
How much can you inherit without paying federal taxes? ›
There is a federal estate tax, however, which is paid by the estate of the deceased. In 2024, the first $13,610,000 of an estate is exempt from the estate tax. A beneficiary may also have to pay capital gains taxes if they sell assets they've inherited, including stocks, real estate or valuables.
Should I cash out inherited stocks? ›
For example, if your father paid $50 for a share of stock and it was worth $250 on the day he died, your basis would be $250. If you sell the stock immediately, you won't owe any taxes; if you hold on to it, you'll only owe taxes (or be eligible to claim a loss) on the difference between $250 and the sale price.
Do inherited stocks have to be sold? ›
Understanding Inherited Stocks
Beneficiaries can do what they want with the stock they inherit. The options are to keep or sell it. If someone decides to keep the inherited stock, it isn't subject to a tax by the Internal Revenue Service.
How do I report inherited stock? ›
You will report the sale of the stock on Part II of Schedule D, Capital Gains and Losses, because inherited stock qualifies for long-term capital gain treatment. You will report the sales proceeds in column (d) and then report your “basis” in column (e).
What happens if you inherit a brokerage account? ›
Transfer account ownership
After you find out that you're inheriting an investment account, your first step is to contact the account custodian. The custodian is the entity that holds the account1 and ensures its safekeeping and that all necessary IRS regulations are met.
How do I report inherited stock sales? ›
You will report the sale of the stock on Part II of Schedule D, Capital Gains and Losses, because inherited stock qualifies for long-term capital gain treatment.
What happens to shares in a deceased estate? ›
When someone passes, the executor of their will can choose to either to sell some or all of the shares owned by the deceased and pay the proceeds to each beneficiary, or they could transfer the ownership of the shares to the beneficiaries.
What is the cost base for inherited shares? ›
If the date of acquisition was before 20th September 1985, your cost base becomes the market value of the asset at the date of death. If the date of acquisition was after 20th September 1985, your cost base becomes the original cost of the asset plus or minus any applicable adjustments to the cost base.
The capital gains tax is a levy on the gain, or increase, in the value of a capital asset over its basis. Capital assets include real estate, business property and equipment, jewelry, antiques, stocks, bonds, mutual funds, mineral rights, royalties, and some intellectual property like patents. The value is the amount that you sell it for or can sell it for, while the basis is the amount you paid, plus acquisition and improvement costs.