Posted on January 12, 2024 by Katherine Fox

What Inheritors Need to Know about Concentrated Stock Positions

It is not unusual for inheritors to deal with concentrated stock positions; holding a long-term concentrated position is a common way to build family wealth. Rather than selling concentrated stock positions during their lifetime, many grantors prefer to die holding those positions and pass them on to their heirs to receive the step-up in basis and associated benefits. 

Inheritors dealing with a concentrated stock position will have a different set of questions and concerns than those who built or grew a concentrated stock position during their lifetime. 

Understand How the Stock Position is Being Inherited

When you inherit a concentrated stock position, you need to understand how the position is being inherited and if it will receive a step-up in basis. 

The best way to get this information is by asking a qualified estate planning attorney the following questions:

• Will the concentrated stock position receive a step-up in cost basis?

• Will the concentrated position be held in a trust for my or other’s benefit?

• Will I be inheriting a concentrated stock position through more than one account type?

Use answers to these questions and the following information to build a plan to manage an inheritance containing a large position in a single stock.

Review the Relative Benefit of Holding a Single Large Position

How to decide what to do with a large concentrated stock position from an inheritance. 

If you inherit a large concentrated stock position from an inheritance you need to review the relative benefit of holding a single large position against the associated risks. Concentrated positions in a single stock can be a fantastic way to build wealth. If you are inheriting a large position in a single stock this is likely an important part of your own family’s wealth journey. 

On the other hand, concentrated positions in a single stock carry a high degree of risk. Putting your eggs in one basket conveys a significant amount of risk and increases the odds that a single market swing could wipe out a large portion of your wealth. 

Because most inheritors can sell out of concentrated positions with minimal tax impact, this is the most common route taken after inheriting a concentrated stock position.

Inheriting a concentrated stock position and receiving a step-up in basis decides what to do with a large position in a single stock fairly simple. The step-up in basis provides freedom from paying significant taxes on embedded capital gains and allows you to make decisions on using proceeds from the concentrated stock position for personal use or to rebalance your portfolio. 

Diversify a Concentrated Stock Position from an Inheritance

Let’s talk about how to diversify:

1. Diversify a concentrated stock position all at once

Diversifying all at once can be an appropriate strategy for inheritors who do not have to worry about significant embedded capital gains due to a step-up in cost basis, or who have a low risk tolerance for holding a concentrated position. This method should be undertaken in conjunction with a financial advisor and a CPA who can work together to make sure that your long-term financial goals are being served by any plan to sell a large amount of stock at once. 

2. Diversify a concentrated stock position over time

Those with a higher risk tolerance may choose to maintain a set percentage of their total net worth within a concentrated stock position and build a plan to diversify the remainder of their position over time. The greatest challenge to diversifying over time is the human element. If you have committed to selling 5% of a concentrated position every 6 months, it can be difficult to pull the trigger if the stock is down (“let’s just wait for it to go back up”) or if the stock is up (“let’s wait for it to go higher”). This strategy requires a high degree of discipline and, often, the guidance of a financial advisor to remind you of your long-term goals and help navigate the emotional issues associated with diversifying a large stock position. 

3. Take the risk and accept the consequences of holding a concentrated stock position

For emotional or financial reasons, some inheritors choose to do nothing with concentrated stock positions and roll the dice on where the market takes them. This strategy can grow inherited wealth or leave you holding a large amount of worthless stock. Those who are committed to holding a large percentage of their net worth in a single stock should take the time to fully evaluate the impact on their life and future financial health if the stock were to take a 50% or 100% drop from which it would never recover. “It’s going to keep going up” is not a basis for sound decision-making where an investment portfolio is concerned.

Understand the Cost Basis of Inherited Stock and if Capital Gains Tax is Due

Here’s an example of what could happen:

Consider two siblings who inherit an $18 million dollar estate split 50/50. The estate does not owe any Federal or State estate tax. 

The estate consists of an IRA worth $5 million and a brokerage account worth $13 million. The brokerage account holds a single position, a concentrated stock position in Microsoft. The brokerage account is titled in the name of a revocable trust, so it bypassed probate and was distributed directly to the two siblings.

The concentrated stock position in the brokerage account was originally purchased for $2 million. Each sibling will receive the following:

50% of brokerage account - current value $6.5 million, cost basis $1 million

50% of IRAs - current value $2.5m, cost basis is not applicable due to IRA taxation rules 

If the siblings each sell their full holding in the brokerage account, they will receive $6.5m each. Under normal taxation rules, they would also owe tax on $5.5 million of capital gains - the difference between the value they sold assets for ($6.5 million) and the cost basis, or the value at which assets were purchased ($1 million). 

Because the siblings inherited through a revocable trust they received a step-up in basis. Instead of being valued at their original purchase price of $1 million, the brokerage account containing Microsoft had its cost basis “stepped up” to the share’s value as of the decedent’s date of death. 

Instead of owing taxes on $5.5 million of capital gains, each sibling sells their full position in Microsoft and receives the proceeds tax free.  

Inheritors who receive a step-up in basis may not have to deal with paying capital gains taxes after the death of a loved one. However, not all inheritors will receive a step up in basis on inherited assets.

Assess if You will Receive a Step-Up Basis

If you inherit from an irrevocable trust you may not receive a step-up in basis on concentrated stock positions held within the trust. 

Not all inheritors will receive a step-up in basis when inheriting a concentrated stock position or other assets. 

Using the same example above, we can alter the scenario so that the two siblings are inheriting from an irrevocable trust instead of a revocable trust. The irrevocable trust was set up by their parents and will distribute assets out directly to the siblings. 

Assets held within an irrevocable trust that are not included as part of a decedent’s estate do not receive a step-up in basis. The siblings receive the same inheritance:

50% of brokerage account - current value $6.5 million, cost basis $1 million

50% of IRAs - current value $2.5m, cost basis is not applicable due to IRA taxation rules 

If the siblings liquidate the brokerage account, they will receive $6.5m each in proceeds. Because they did not receive a step-up in basis on assets inherited through an irrevocable trust,  they would also owe tax on $5.5 million of capital gains - the difference between the value they sold assets for ($6.5 million) and the cost basis, or the value at which assets were purchased ($1 million). 

Inheriting a concentrated stock position without receiving a step-up in basis makes the decision about what to do with a large position in a single stock difficult. Maintaining a concentrated position in a single stock creates a high level of risk, but diversifying the position by selling it all at once and paying capital gains in one year may not be a tax efficient decision. 

What to do if you inherit a concentrated stock position held in trust for your benefit

If you inherit a concentrated stock position held in trust for your benefit, decisions about the position will be made by the trustee, or by the investment advisor for the trust. Depending on how the trust is set up, the trustee may be a relative, close friend of your family, or a corporate trustee. 

Because trustees have a fiduciary responsibility to steward trust assets, they generally will not be willing to hold a large position in concentrated stock. A concentrated position can expose the trust to unacceptable levels of risk and potential litigation should the stock fall significantly in value and deplete trust assets. 

If you are the beneficiary of assets held in trust for your benefit and want to maintain some, or all, of a concentrated stock position, your best bet is to make an argument to the trustee as to why the trust should continue to hold the position. Depending on the language in the trust, your relationship to the trustee, and the number of other beneficiaries to the trust, you may or may not have success in making the argument.

Ultimately, trust income and principal beneficiaries generally do not have discretion over the investments of trusts for the benefit, meaning your power in this situation is limited.

What to do when you inherit a concentrated stock position through an IRA, revocable trust, and irrevocable trust

Some inheritors may inherit a concentrated stock position through retirement accounts, brokerage accounts, and trust accounts. In this case it is advisable to review your exposure to a concentrated stock position as a percentage of your total net worth. 

Next, it is generally prudent to begin trimming the concentrated position to reduce risk. The first step is identifying which accounts would have the lowest tax impact from selling stock. Retirement accounts and accounts that received a step-up in basis, such as brokerage accounts or accounts inherited from a revocable trust would be the first area to look to sell a concentrated position of inherited stock with minimal capital gains tax impact.

After you sell and diversify the portion of a concentrated stock position with minimal tax impact, inheritors should compare the size of the concentrated position within their total portfolio against the tax impact of selling out of that position. Working with a financial advisor and accountant can help determine the appropriate risk/reward of holding the stock and create a timeline to diversify your portfolio with the lowest possible tax impact.

Let’s take the next step together

Understanding what happens when you inherit a concentrated stock position isn’t easy. Beneficiaries can encounter a wide variety of different situations requiring knowledge and finesse to manage. If you need more help, you can download The 20 Terms Inheritors Need to Know, or reach out to Katherine Fox, CFP®, CAP®, financial planner for inheritors to learn how Sunnybranch can help you build a plan to manage your inheritance from a trust.