Deciding the value of an estate determines whether -- and how much -- tax will be paid before the estate is distributed to the heirs. Part of that process also determines whether -- and how much -- capital gains tax will be paid in the future by persons who inherit stocks.
Value of Inherited Stocks
The value of inherited stocks is determined by the date of death. Generally, the price is the market closing price on that date. If the person dies on a day the stock market is closed, the value reverts to the last closing price before the death.
Estate tax law allows the executor of an estate to choose an alternative date, which will be six months after the date of death. However, the alternative valuation date must be used by the entire estate. The executor can't use the primary valuation date for some assets and the alternative date for others.
Estate Tax Assessment
The tax legislation in 2001 and 2003 known as the Bush Tax Cuts provided for the gradual repeal of the estate tax. In 2010, when the Bush Tax Cuts were scheduled to expire, there was no estate tax. When most of the Bush Tax Cuts were extended through 2012, the estate tax was pegged at 35 percent on the part of an estate over $5 million. To put this in stock terms, there would be no estate tax on 50,000 shares of stock valued at $100 each. But if the stock were valued at $105 a share, the estate must pay tax on $250,000 -- a total of $87,500 -- before the shares can be distributed to the beneficiaries. It's impossible to guess what tax rate might be imposed on estates after 2012.
Income From Inherited Stock
Inherited stocks are not considered income, so you need not report them on your income tax return. However, any income derived from those assets -- through dividends or sale of shares -- must be reported.
Determining Tax Basis
Tax laws make it relatively easy to determine your tax basis on inherited stock or mutual fund shares. Put simply, the tax basis is the price of the shares on the valuation date. The basis in the shares is considered to have "stepped up" or "stepped down" to the date-of-death value. For example, if your dad bought 100 shares of Get Rich Quick in 1951 for $10 each, his tax basis was $1,000. Over the next 60 years, the stock split a few times and increased in value, so when he died, he left you 650 shares at $20 each -- $13,000. Rather than inherit his tax basis, you get the stepped-up basis of $13,000. If you sell the stock a week after his death at $21 a share, your capital gains would be only $650.
Getting the Date Right
If an executor filed a tax return on an estate that included your shares, it's important to know which valuation date was used so you can figure your tax basis. Although it is to your benefit to receive the highest stepped-up value, it is in the estate's best interest to use the lowest valuation, reducing the pre-distribution tax. In most cases, estates are too small to require a tax return, and the default valuation date is the death date.
Timing of Sale
The step-up in basis does not occur until after midnight on the death date. Any securities sold on the day the person died would inherit the decedent's tax basis. If securities are sold between the date of death and the alternative valuation date chosen by the executor, both the tax basis and the valuation for the estate would become the price at the time of the sale.
Selling your inherited stock will always yield a long-term capital gain or loss, regardless of how long you hold it or when it was originally bought by the decedent.
Dale Bye has spent more than 40 years in journalism, including 25 supervising reporters and editors at metropolitan newspapers and eight years as senior managing editor at a national sports magazine. He directed five newspaper-sponsored personal finance fairs. His fields of expertise include business and personal finance, sports, fitness and theater. Bye holds a Bachelor of Journalism from the University of Missouri.