Oblivious Investor reader Chris writes in to ask:
“Some time in the next month or so, I’m going to be inheriting about $45,000 worth of various stocks from an uncle of mine who passed away earlier this year.
I don’t have a clue what to do with a portfolio of individual stocks, so I’d like to sell them and allocate the money to my normal index fund portfolio. But I’m a bit worried to sell them, because I don’t know how to calculate the applicable capital gains taxes.
Inherited Cost Basis = Fair Market Value (Usually)
In most cases, if you sell the property soon after inheriting it, your capital gains should be fairly small. This is a result of the fact that, in general, when you inherit property, your cost basis is equal to the fair market value (FMV) of the property at the time of the decedent’s death.
Alternatively, if the administrator of the estate elects to use the “alternate valuation date” for the estate (and if this is the case, you should be informed of such an election), then your cost basis will be equal to the fair market value of the property on the earlier of:
- 6 months after the date of death, or
- The date that the property was distributed to you.
(Though again, this will usually result in any capital gains being small-to-nonexistent if you sell the property soon after receiving it.)
Note: Exceptions may apply for inherited property that was used in a closely held business or for farming
Holding Period for Inherited Property
Inherited property is considered to have a holding period of greater than one year, regardless of how long you’ve held the property or how long the decedent held the property. As such, any capital gains or losses will be considered long-term capital gains/losses.
Takeaway: Based on current tax law, the gains will be taxed at a maximum rate of 15%.
Special 2010 Cost Basis Rules
While we’re on the topic, it’s worth pointing out that if the person in question had died in 2010, the applicable rules would have been different. Specifically, administrators of estates of decedents who died in 2010 were allowed to choose between the rules that had originally been in place for 2010, or the rules that were scheduled to be in effect for 2011.
- If the administrator elected to use the 2010 rules (under which there was no estate tax), the recipients of the inherited property would have received the decedent’s cost basis in the property as their cost basis.
- If the administrator elected to use the 2011 rules (35% estate tax, but with a $5 million exemption), the recipients’ cost basis would be the FMV at the date of death (or FMV using the alternate valuation date, as described above).
As you might imagine, most estates were well below the $5 million exemption, so using the 2011 rules was usually best because it allowed the recipients to use the fair market value as their cost basis rather than having to use the (usually lower) cost basis of the decedent.
(Note: The above discussion relates to inherited taxable property. See here for inherited IRA rules.)