Long embedded in the federal tax code is a provision that provides important advantages for people who sell inherited stocks, real estate or other investments that have appreciated in value.
Internal Revenue Code Section 1014 authorizes tax breaks for inheritors. In tax lingo, the basis (the starting point for measuring gain or loss) of inherited assets “steps up” from their original basis (cost, in most instances) to their date-of-death value. It’s as if the inheritors had bought the assets that day.
There’s a limited exception for executors of estates. They’re allowed to use an alternative valuation date for inherited assets — six months after the date of death.
Put another way, inheritors of, say, shares of stocks sidestep taxes on their increase in value while they were owned by the person who bequeathed them.
An example: Assume that your aunt left you shares of an airline. She paid $10,000 for the airline’s shares that were worth $250,000 at her death. Subsequently, you unload them for $300,000.
How does a stepped-up basis benefit you? Your basis for the shares automatically increases from $10,000 to $250,000, their market value at the date of her death. A basis of $250,000 for the shares shrinks your taxable profit to just $50,000 — their increase in value between the time your aunt died and the time you sell them for $300,000.
You forever escape capital gains taxes on the $240,000 increase in value between the time your aunt bought the airline’s shares and the time she died. The amount she paid for the shares is irrelevant.
With that kind of scenario, here are some reminders for your aunt and you. Your aunt’s financial adviser should remind her that a stepped-up basis trims taxes. That should prompt your aunt to remind the executor of her will to determine the date-of-death value of the airline’s shares. Finally, the executor should remind you to avail yourself of the stepped-up basis in order to determine gain or loss whenever you sell the shares.
Your aunt and her adviser shouldn’t think that their work is done. They also ought to discuss how best to determine date-of-death values for her other holdings.
Your aunt owns substantial amounts of properties that, unlike shares traded on exchanges, usually aren’t sold on a regular basis. The many possibilities include shares in closely held companies, a main residence, a second home, rental property and other kinds of real estate, jewelry, artwork, antiques and other collectibles.
Those kinds of assets might require appraisals. Appraisals obtained now for inexpensive amounts might avoid hefty payments to attorneys, accountants and other advisers in order to resolve disputes with federal and state tax collectors later on.
In a subsequent article, I’ll go into more detail about sales of inherited assets.
Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 250 and counting).
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes...