Sometimes an inheritance includes more than a house or an heirloom vase. Investors can choose to pass down to their heirs financial securities like stocks. Determining the value of such a bequest is vital. Without the proper calculations or procedures, you could face hefty tax consequences. The most important step to figuring out your inherited stock is to find the cost basis. Here’s a rundown on how that works.
Consider working with a financial advisor on estate planning challenges, such as how to value things you inherit.
Cost Basis Explained
In general terms, cost basis is the original price you paid to purchase something. In this case, it’s the purchase price of an asset like a stock and it’s adjusted for anything that impacted the value, i.e., dividends, commissions, fees or gains.
The cost basis helps investors, inheritors and estates know the capital gain or loss on an asset. To find that value, you calculate the difference between the current market value and its appropriate cost basis.
Cost basis is expressed in a dollar amount or a per-share equivalent.
What Is the Cost Basis of Inherited Stock?
Finding the cost basis of inherited stock may sound intimidating, but it’s actually simple. It depends on the value of the stock at the time the previous owner died. The only exception is if the estate chose an alternate valuation date. In that case, you determine the value of the stock six months post the death date.
For example, let’s say someone bought Apple stock in early 1990. She purchased it at around $0.40 per share and then sold it roughly 30 years later before she passed. The owner would owe taxes on the gains made by the stock. But, if she included the stock in her will to hand over to an heir, then the cost basis would reset. The price would fix itself on the day of the deceased’s passing (or the chosen valuation date). This perk is known as the stepped-up basis loophole. Thanks to it, the heir pays much less in taxes since the capital gains shrink.
Suppose a person buys shares from a company and pays $8,000. But it rose in value to $64,000 as of the person’s death date. The tax perk makes the cost basis $64,000, which means you do not have to pay taxes on the $56,000 original capital gain. This makes the stepped-up basis a valuable part of estate planning.
How to Figure out The Cost Basis of an Inherited Stock?
Once you inherit stock, you’ll need to research its pricing. In particular, you have to find its per-share price at the date of the previous owner’s death. This is even more important if some time has elapsed since the person passed down the stock to you. Even if it’s been a while, you should still have access to that information. You can contact the investor relations department of the stock’s company or search through sources that report financial news.
Whether you inherited the stocks through a brokerage, will or trust, calculating the cost-basis stays the same. However, the stepped-up rule only applies to inherited stocks (and other financial securities) passed on from a deceased’s estate, not gifts or irrevocable trusts made before the death.
Keep in mind: Purchasing shares on top of those you inherited don’t count toward the inherited stock’s cost basis. For example, you might have enrolled in a program that automatically reinvests your dividends. Any new shares are separate from the old ones, though. So, if you’re not careful, you may pay more capital gains tax by grouping them.
Calculating the Valuation for Estate Tax Purposes
There is a threshold to estate taxes. It’s only levied on estates that exceed the exclusion limit set by the IRS. The 2021 threshold is $11.7 million for individuals and $23.4 million for married couples. However, only the amount that goes over the minimum will actually face the tax. It’s also a progressive tax, with a beginning rate of 18% and a capped rate of 40%. You can review the 2020-2021 federal estate tax rates in our guide.
A valuation of the stock’s cost basis helps determine if the estate exceeds those numbers. But as long as the estate’s overall value sits below limits, the heir won’t face taxes as part of the inheritance.
Other Tax Considerations on Inherited Stocks
You might not have to go looking for the cost basis of the inherited stock. If the deceased individual’s executor filed a tax return for the estate, then use the values reported there as the cost basis. If you’re not so lucky, you can still find the data on financial news reports.
Also, some states require heirs to submit a tax waiver for their inherited accounts. They can also vary in their estate and tax laws. Talk with a financial professional or your state’s revenue or tax department to find the right documents.
The Takeaway
Losing someone in your life is a difficult experience. It’s already enough that you have to deal with the emotional burden, but finances can make the stress unbearable. Many people will want to take advantage of your lack of knowledge and confusion if they know you’ve come into any money after the death. Creditors and those selling investments may try to manipulate you. Don’t tackle this kind of situation alone. Talk to a financial advisor. They can guide you through the process and take the pressure off your shoulders.
Estate Tax Planning Tips
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A financial advisor is a valuable asset when you need to navigate an estate plan. Lacking the right knowledge can leave you scrambling when taxes begin to hit. SmartAsset makes it easy to find one with its free match tool. It connects you with local advisors ready to help. If you are ready to take on your financial goals, get started now.
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If you want to set up and plan your retirement goals, SmartAsset’s retirement calculator can help you figure out how much you will need to save to retire comfortably.
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Estate planning involves multiple moving parts – the stepped-up basis loophole is just one. Estate taxes are another. Researching ahead of time will allow you to work through your estate planning or legacy planning as you see fit.
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