Inheritances of property, like stocks, have no tax implications at the federal level unless and until you do something with them. The Internal Revenue Service doesn’t collect an inheritance tax, although six states do. But these aren’t income taxes – they’re a percentage of the value of a gift that an individual receives from an estate. Otherwise, as far as the IRS is concerned, if you inherit stocks and just sit back and watch them grow in value, no tax bill will come due. But when and if you cash them out, capital gains taxes can come into play. This tax is assessed on the difference between what it cost you to acquire an asset, called your basis, and the amount you sell it for.
Inheritances Receive a Stepped-Up Basis
Obviously, you don’t purchase an inheritance, so the IRS needs another way to determine your basis in inherited stocks – and the federal government is actually pretty kind in this regard. Inheritances receive what is known as a stepped-up basis, usually to the date of the decedent’s death, although estates have the option of valuing property six months after this date instead. So your basis isn’t what the decedent first paid for the stocks. That could be very little, particularly if the purchase was made years ago, and your gain if you sell in the current market could be significant; you’d have a much higher tax bill. If you cash in the stocks virtually immediately after you inherit them, it’s possible that you’d have no gain in value at all, so no taxes would be due.
Capital Losses on Stocks
Given the ups and downs of the stock market, it’s also possible that you could actually have a loss when you sell the stocks. They might have been worth $10,000 on the decedent’s date of death, but then the market turns shaky so you decide to cash them in. If you sell them for $7,500, you now have a $2,500 capital loss. Again, the stepped-up basis is critical. If the decedent had been losing money on those stocks for years, you can’t tap into those losses. Your losses begin on the date of his death or on the alternate valuation date.
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The Effect of a Loss on Other Income
Capital gains – or losses – are entered on line 13 of the Form 1040 tax return so they either reduce or add to your overall taxable income. If you also have capital gains from other investments, your $2,500 loss is deducted from those gains to reduce the total you must enter on line 13. If the stocks were your only investment property subject to capital gains tax, or if all your investments lost money, you can enter the negative number of your loss on line 13. But you can only do this for losses of up to $3,000 a year. That $2,500 would slide in under the limit, but if you lost $3,500, you’d have to claim a $3,000 loss this year and the remaining $500 next year.
The Long-Term Tax Rate
Capital gains tax rates depend on whether you own an asset long term or short term. Normally, you must hold ownership of an asset for at least one year to qualify for the more favorable long-term rates. Any asset owned for less than a year before you sell it is taxed as ordinary income according to your tax bracket, and this can be a significantly higher rate. But the IRS taxes all capital gains on inheritances at the lower long-term rate. You can hold the stocks for one day or for 10 years and still get that long-term rate: zero percent for single taxpayers who earn up to $38,600 as of 2018 or 15 percent for those who earn between $38,601 and $425,800. These thresholds increase to $77,200 and $479,000 for married taxpayers who file joint returns. Those with incomes higher than this pay 20 percent.
- Kiplinger: The Tax Hit on Inherited Stock
- Financial Web: Taxes on Inherited Stock
- NJ.com: What Taxes Are Owed on Inherited Stocks?
- IRS: Gifts and Inheritances
- Tax Foundation: Does Your State Have a State or Inheritance Tax?
- IRS: Form 1040
- Fox Business: Stocks, Taxes and Profits – What You Need to Know in 2018