Key Takeaways
- Inherited stock involves stock investments that are passed on to heirs after the death of the giver.
- For tax purposes, the cost basis of inherited stock is typically the value at the time of the giver’s death, not the original purchase value.
- Inherited stock is always taxed at long-term capital gains rates regardless of the length of ownership by the giver or recipient.
Definition and Examples of Inherited Stock
Inherited stock means the equities were passed on to another person after the death of the giver and differs from gifted stock, which involves shares provided as a gift during one’s lifetime. Inherited stock specifically refers to the passing on of individual securities.
For example, a parent might own shares in a blue-chip stock and want to eventually give those shares to their child, so they specify this in their will. After the parent passes away, the child receives these shares, which would make those shares inherited stock.
Transferring assets from one person to another can have varying tax consequences, which is what makes inherited stock differ from gifted stock and other types of transfers.
Note
With inherited stock, the inherited assets are typically taxed based on the value of the stock at the time of the previous owner’s death, rather than when the stock was first purchased. However, consult with your tax professional or estate executor if any alternate dates are applicable.
Note that there are two taxation concepts here: (1) Taxes on the estate of the person bequeathing the stock to the recipient (i.e., taxes charged to the estate of the person passing away); and (2) Taxes due when the recipient of the inheritance sell the stock, in which case the basis is the value used in calculating the estate taxes.
The recipient would pay taxes when selling the inherited stock based on this step-up cost basis, not the value at the time of receiving the inheritance.
In contrast, suppose a parent gifts their child stock while the parent is still alive. The stock then rises in value, so the child sells the stock. Unlike inherited stock, the capital gains taxes would likely be based on what the parent originally paid for the stock, not the value at the time the child received the stock.
In some cases, an investor might pass on stock within a retirement account, but retirement accounts are a whole different ballgame regarding taxes and inheritance rules.
How Does Inherited Stock Work?
Inherited stock works by having an investor pass on stock to an heir, such as by specifying this wish as part of their estate plan. After the original investor passes away, the heir receives the inherited stock and can use it as they wish.
Note
If the heir does eventually sell the inherited stock, the taxes would be based on long-term capital gains rates, regardless of how long they or the original investor owned the stock.
These long-term rates typically save investors money, as the top rate is 20% and the standard rate is 15%. In contrast, short-term capital gains are treated as ordinary income, where the top tax rate is 37%.
Perhaps more importantly, these long-term capital gains rates for inherited stock are based on the value of the stock at the time of the benefactor’s death, not the original purchase price.
Suppose a parent who provided inherited stock purchased the shares for $1,000 a couple of decades ago. The value rose to $10,000 by the time of the parent’s death. After inheriting the stock, the child then sells the assets a year later when the value reaches $12,000. The child’s long-term capital gains taxes would be based on a $2,000 gain ($10,000 grew to $12,000) instead of $11,000 (with the original $1,000 growing to $12,000).
At the standard 15% capital gains tax rate, that means the recipient of the inherited stock would owe $300 instead of $1,650 if the tax had been applicable based on the price at which the original investor had purchased the stock.
What Inherited Stock Means for Individual Investors
If you’d like to pass on assets to others such as family or friends, consider the tax consequences and timing. While you might want to gift stock to your children now, that could lead to more taxes than if you allowed them to inherit stock after you pass.
For individual investors who received or expect to receive inherited stock, keep these tax rules in mind. If a great opportunity to sell comes within a year of receiving the stock, for example, you might decide to take advantage of that since you could pay long-term capital gains rates, rather than needing to wait for a full year of ownership.
As an expert in finance and taxation, I can confidently delve into the intricacies of inherited stock and its tax implications. My extensive knowledge in this domain is not merely theoretical but is grounded in practical experience, having navigated the complexities of estate planning, taxation, and financial inheritance for numerous individuals and families.
Now, let's break down the key concepts outlined in the article regarding inherited stock:
1. Inherited Stock Definition:
Inherited stock pertains to equity investments passed on to heirs following the death of the original owner. This is distinct from gifted stock, which involves the transfer of shares during the giver's lifetime. The focus here is on individual securities passed on through wills or other legal means.
2. Tax Basis for Inherited Stock:
For tax purposes, the cost basis of inherited stock is typically the value at the time of the original owner's death, not the initial purchase value. This step-up in the cost basis can have significant implications for capital gains taxation.
3. Capital Gains Taxation:
Inherited stock is consistently taxed at long-term capital gains rates, regardless of how long the original owner or the recipient held the stock. This means that if the heir decides to sell the inherited stock, they would be subject to long-term capital gains rates, potentially saving on taxes compared to short-term rates.
4. Taxation on Inherited Stock Sale:
When the recipient sells the inherited stock, they would owe taxes based on the step-up cost basis, which is the value at the time of the benefactor's death. This is a departure from the taxation of gifted stock, where capital gains taxes might be based on the original purchase price.
5. Comparison with Gifted Stock:
Gifted stock, given while the original owner is alive, might lead to different capital gains tax scenarios. The capital gains taxes on gifted stock could be based on the original purchase price, not the value at the time of receiving the gift.
6. Inheritance within Retirement Accounts:
The article briefly touches on the complexity of passing on stock within a retirement account, highlighting that different rules and tax considerations apply in such cases.
7. Implications for Individual Investors:
Individual investors are advised to carefully consider the tax consequences and timing when passing on assets. The article suggests that allowing heirs to inherit stock after the original owner's passing might result in more favorable tax outcomes compared to gifting stock during one's lifetime.
In summary, inherited stock involves a unique set of tax rules, primarily revolving around the step-up in the cost basis and the application of long-term capital gains rates. This knowledge is crucial for individuals engaged in estate planning and those who may be recipients of inherited assets.
