How are inherited stocks taxed when sold?
How are inherited stocks taxed when sold?
You’re here because you need help understanding the tax consequences of selling inherited stock.
I’ve got you. I’m Katherine. I’m a CERTIFIED FINANCIAL PLANNER™, a financial advisor for inheritance, and a fellow inheritor.
Keep reading for the ESSENTIAL guidance you need to understand the tax consequences of selling inherited stock and my advice for building a tax-efficient plan to manage inherited stock.
Posted on August 15, 2024 by Katherine Fox.
How are inherited stocks taxed when sold?
Most people don’t have any idea how their inherited stocks will be taxed when they sell.
You’re trying to learn an entirely new knowledge set while you’re grieving and managing a stupid amount of other death-related details.
You may have considered looking for an inheritance financial advisor to help.
In the meantime, you’re stuck with more questions than answers.
You might be wondering:
How are inherited stocks taxed?
How are inherited stocks taxed when sold?
How does the step-up in basis affect the tax treatment of inherited stocks?
Did I get a step up in basis on my inherited stocks?
How can I learn the cost basis of my inherited stocks?
How are inherited stocks held in an IRA or 401(k) taxed when sold?
Should I sell inherited stocks?
Luckily, you ended up here.
Keep reading for the 7 ESSENTIAL things you need to know about how inherited stocks are taxed when sold.
You’re closer than ever to finding answers to your questions and moving forward with a tax-efficient plan to sell, manage, and grow your inheritance.
I’m Katherine. I’m a CFP® and a financial advisor for inheritance.
I’m here to help you through this journey, whatever your needs are.
If you’re trying to get up to speed, check out the 20 Terms Inheritors Need to Know or How to Talk to Your Parents About Their End-of-Life or Estate Plan.
And if you’re deep in the weeds and don’t know what to do next, schedule a FREE consultation to see how I can help you build a tax-efficient plan to sell your inherited stocks.
1.lHow are inherited stocks taxed?
The taxes you pay on inherited stocks depend on the state where the person you inherit from lived.
No tax is due specifically upon the transfer of inherited stocks from a deceased person to their heirs.
However, taxes may be due as an estate tax paid by the deceased person’s estate or as an inheritance paid by you as an estate beneficiary.
There are two types of estate or inheritance taxes that beneficiaries need to understand:
Estate Taxes
Estate taxes are paid by the estate itself. They are not the responsibility of estate beneficiaries.
Estate taxes are due based on where the person who lived died and also states where they owned real property.
Inheritors should consider both Federal and state estate taxes.
As of 2024, most estates are not subject to Federal estate tax. The Federal estate tax exemption limit is over $13 million for an individual and $26 million for a married couple.
This limits Federal estate tax consideration to the wealthiest families, with the caveat that these rates are scheduled to sunset back down to ~$7 million per individual / $14 million for a married couple in 2026. This leaves room for many more families to get snagged by an unexpected Federal estate tax bill.
12 states and the District of Columbia have estate taxes. Tax rates and exemption amounts vary by state, with some states pegging their exemptions to the Federal estate tax rate and other states (like Oregon) with exemptions as low as $1 million.
State Inheritance Taxes
Inheritance taxes are paid by estate beneficiaries. They are not the responsibility of the estate.
Inheritance taxes are due based on the state where the person who lived died, and also states where they owned real property. They are not levied based on where estate beneficiaries themselves live.
6 states have inheritance taxes. All six of these states exempt spouses. Some states also fully or partially exempt immediate relatives.
7 ESSENTIAL things you need to know about how inherited stocks are taxed
Keep reading to get educated and ensure you’re making the best long-term decisions when evaluating a plan to sell inherited stocks.
2. How are inherited stocks taxed when sold?
How your inherited stocks are taxed when sold depends on the cost basis of the inherited positions you received.
The cost basis is the amount that a stock (or security) was purchased for.
For example:
If I purchased a share of Amazon stock in 2001 for $20, my cost basis in that share of stock is $20.
If I decide to sell that share of stock in 2024 when the price hits $200, I will have realized $180 in long-term capital gains and I will have to pay taxes on that $180 of realized gains.
Most inheritors, however, will receive a step-up in basis on their inherited stocks. This step-up in basis will affect the tax treatment of inherited stocks and is discussed in further detail in the next section.
Before moving on, it is crucial to note the tax rates inheritors need to understand before selling inherited stocks.
In normal circumstances, when selling an appreciated asset like inherited stock you will be subject to different tax rates depending on how long you have held the asset:
Short-Term Capital Gains
Short-term capital gains are assessed on assets that are sold after being held for less than one year. Short-term capital gains tax rates are equal to income tax rates.
Long-Term Capital Gains
Long-term capital gains are assessed on assets that are sold after being held for one year or more. Long-term capital gains rates are lower than income tax rates, with the highest rate being 20% versus a top bracket of 37% on the income tax schedule.
When selling inherited stock, this distinction does not apply. Your holding period is ALWAYS considered to be long-term.
Let’s use another example:
Say my grandma purchased a share of stock for $50 the day before she died.
I inherited that share of stock two months later. In the meantime, the company had a breakthrough and my single share is now worth $1,000.
Even though the stock has only been held for two months and one day, if I sell the gain will still be treated as long-term capital gains because I inherited the position.
If, instead my grandma stayed alive and sold the stock herself two months later, she would have been responsible for paying short-term capital gains on her $950 sale proceeds.
3. How does the step-up in basis affect the tax treatment of inherited stocks?
While it’s important to understand how inherited stocks are taxed when sold, most inheritors won’t have to deal with this issue
That’s because the vast majority of inherited assets receive a step-up in basis.
Let’s start by explaining the step-up in basis.
It is a special rule for inheritors that adjusts the cost basis of most inherited assets to their fair market value as of the deceased person’s date of death.
Consider a new example:
My grandma held a share of stock she purchased for $50. When she died, the company was on a tear and the share was worth $1,000.
When I inherit that share of stock, my cost basis is $1,000 - the value of the stock as of my grandma’s date of death. I do NOT inherit her $50 cost basis.
Beneficiaries who receive the step up in basis on inherited stocks and immediately sell them may not have to deal with significant taxable gains or losses, assuming their fair market value has not changed significantly since the decedent’s date of death.
However, even beneficiaries who received a step-up in basis may need to worry about taxes if they are selling stock in the months and years after a loved one’s death.
Any price changes that occur after the date upon which assets were “stepped up” in cost basis will not be captured and must still factored into a long-term tax plan when determining how your inherited stocks will be taxed when sold.
“Beneficiaries who receive the step up in basis on inherited stocks and immediately sell them may not have to deal with significant taxable gains or losses, assuming their fair market value has not changed significantly since the decedent’s date of death.
However, even beneficiaries who received a step-up in basis may need to worry about taxes if they are selling stock in the months and years after a loved one’s death.”
4. Did I get a step up in basis on my inherited stocks?
Most inheritors will receive a step-up in basis on inherited assets, including inherited stocks.
There are three primary exceptions to this rule:
Assets inherited through an irrevocable trust do not get a step-up in basis
If the person you inherited from set up an irrevocable trust to hold assets before they died, any assets you receive through that irrevocable trust will NOT get a step up in basis.
Irrevocable trusts are often used as a way to get money out of someone’s taxable estate. When an asset is placed in an irrevocable trust, its value is frozen and it is considered to be outside of a person’s estate.
This is incredibly useful for estate tax planning purposes, as it presents an easy way to remove appreciating assets from the estate tax calculation.
When you inherit one of these assets, however, you will inherit the asset's original cost basis. In the vast majority of cases, you will not receive a step-up in basis on assets inherited through an irrevocable trust.
Assets inherited through title transfer may not get a full step-up in basis
If you inherit property via a title transfer (for example, you are listed as joint tenants on a property and the other joint owner dies) you may not receive a full step-up in basis on the property.
For non-spouse beneficiaries, you will only receive a step-up in basis on the percentage of the property owned by your co-owner.
For example, consider that you and your dad purchased an investment property for $100,000. Your dad paid $75,000 and you paid $25,000 and you hold the property as joint tenants with right of survivorship.
When your dad dies, the property is worth $1,000,000.
You don’t get a full step-up in basis to $1,000,000. Instead, you get a step up in basis for your dad’s percentage of the property. Your new basis is $775,000 (your dad’s stepped-up basis of $750,000 + your original basis of $25,000).
Assets inherited in retirement accounts do not get a step-up in basis
The rules for sales/distributions from inherited IRAs and 401(k)s are different than taxable accounts and the step up in basis discussion does not apply.
If you’re looking to understand the tax consequences of selling inherited stock in a retirement account, skip to point #6 for a full discussion of everything you need to know.
5. How do I know the cost basis of my inherited stocks?
If you did not receive a step up in basis on your inherited stocks, you will need to ensure that the cost basis information you have for your inherited positions is correct.
This can be a difficult and/or impossible project that requires the help of a qualified CPA and an inheritance advisor.
Especially if the stocks you inherited were purchased before 2013, you will need to do some digging and research to see if you can find a record of when the stocks were acquired.
If you aren’t able to find detailed records, knowing when the stocks were purchased should allow you to work with a CPA to review historical data and create a “best faith” estimate of cost basis that would stand if you were to get audited.
6. How are inherited stocks held in an IRA or 401(k) taxed when sold?
You don’t need to worry about paying taxes on inherited stocks held within an inherited IRA or 401(k) account.
These accounts are tax-deferred, meaning that what happens in the account is not subject to tax purposes.
The only taxable event in a pre-tax IRA or 401(k) occurs when you withdraw money from the account. These withdrawals are fully considered taxable income.
Because of the tax treatment of inherited IRAs, 401(k)s, and other retirement accounts, the step-up in basis is not relevant and the tax consequences of selling assets do not need to be considered.
The tax consequences of withdrawing funds, however, are a separate issue. If you want to know more about that, check out my post - Does my inheritance count as taxable income?
7. Should I sell my inherited stocks?
Unfortunately, this isn’t a question I can answer for you in a blog post.
Whether to keep or sell inherited stocks depends on many different factors, including:
Your need for liquid cash
Your time horizon and risk tolerance
Your current portfolio’s diversification and embedded risk
The tax consequences of selling inherited stocks
The outlook for your inherited stocks
The concentration of individual stocks in your portfolio
If you’re looking for help deciding whether to keep or sell inherited stocks and trying to figure out the tax consequences if you sell inherited stocks, reach out and schedule a call.
Sunnybranch is an inheritance wealth management firm, and we help clients like you answer these questions every day. I’d be honored to see how we can help you make a plan to use an inheritance to build a plan that works for YOUR future.
Let’s take the next step together
Understanding how your inherited stocks will be taxed when sold is not easy. Inheritors can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can download The 20 Inheritance Terms You Need to Know, or reach out to Katherine Fox, CFP® and CAP®, a fiduciary, fee-only financial planner to learn how Sunnybranch can help you build a plan to manage, grow, and protect your inherited investments.
