Everyone's indulged in one of those Hollywood-style fantasies about inheriting a fortune from a distant relative they never met. While those daydreams usually feature mansions and luxury automobiles, few dreamers ever ponder the tax consequences of inheriting assets. Inheriting assets such as stocks can be a confusing web of estate tax and capital gains bases, although untangling that web is relatively simple when you attack each tax individually.
First, the good news: If you inherited stock from anyone, when you receive it, it doesn't create any immediate tax burden. While estate planners warn of the consequences of the estate tax, the tax -- much like the gift tax -- doesn't apply to the person who receives an inherited asset. The IRS levies estate taxes against the value of the decedent's estate, and usually collects its tax before assets are divided among heirs. Consider your inherited stocks free of short-term tax consequences when they enter your portfolio.
As an Executor
If you're settling an estate, the tax basis of stocks to be inherited become a concern, but only as an aggregate part of the estate as a whole. When settling the estate, you must declare the gross value of the estate, totaling the value of all investments, real estate and other assets the decedent held. Debts and miscellaneous expenses such as funeral costs may be deducted when you calculate the taxable value of the estate. The IRS exempts the first $5 million in taxable value, then levies a 35 percent tax on any excess value of the estate. This tax bill may be paid using the estate's liquid assets or by selling assets. The remaining value of the estate, including any remaining stocks, may then be distributed among heirs, who receive assets without paying any tax out of pocket.
Capital Gains Tax Basics
Those inherited stocks don't place an immediate tax on you when you receive them, but when you decide to sell them, you may need to pay capital gains on the sale. When you determine the tax basis -- usually the price you paid for an asset -- use the fair market value of the stock on the day you inherited. Use this figure when you calculate gains or losses on the investment. For example, if you inherit 100 shares of stock that traded for $40 per share when you received it, its basis is $4,000. If you sold it for $42 per share, you'd declare $200 in gains -- $4,200 less $4,000 -- not $4,200.
Short- vs. Long-Term Gains
The amount of gains tax you'll need to pay on stocks you inherit also depends upon how long you hold onto them before you sell them. The IRS taxes short-term gains, or proceeds from items held for a year or less, at a much higher rate: Most taxpayers pay 15 percent gains on long-term investments, while short-term gains are taxed at the same rate as your income tax bracket.
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