The rules on estate taxes and inheritance can be confusing, but if you received stocks as part of an inheritance, the good news is the most complicated parts of the tax code are resolved by the deceased’s estate. Once you inherit a stock -- or any other asset -- the Internal Revenue Service (IRS) handles it as if it were any other asset. Because of this, you can transfer stocks without incurring any penalty as long as you calculate capital gains correctly: You’re allowed to “step up” the value of the stock to reflect its value at the time of receipt when you determine its tax basis.
1. Look up the stock’s value on the date that the person from whom you inherited it died. This value serves as its basis for calculating capital gains, rather than the price the deceased paid for it, or the price you paid for it -- zero dollars. In most cases, this will reduce the amount of gains you’ll be liable for.
2. Determine if the deceased held the stock in 401(k). If not, skip to Step 4. If it was a part of a 401(k) plan at any time, you must account for its net unrealized appreciation -- which the IRS refers to as NUA -- and account for the increase in the stock’s value while it was in a tax-sheltered account.
3. Calculate the stock’s NUA by subtracting the price the deceased paid to purchase the stock from its value when it was removed from the 401(k) plan. For example, if your grandmother paid $3 per share for 100 share of stock and the stock’s value was $10 when she died and her estate withdrew it from the plan, for a total value of $1,000. Its NUA is $7 per share, or $700 total. Inherited stocks with a NUA are taxed at the NUA in addition to their basis rate when you sell them.
4. Determine the amount of profits -- on which you’ll need to pay capital gains taxes to avoid a penalty -- you made from transferring them by subtracting the stock’s basis you calculated in Step 1 and any NUA value from its sale price. Report this amount as a capital gain.
5. Determine which gains rate applies to the sale. If you held the stock for more than 365 days, the IRS assesses a 15 percent capital gains tax on your profits. If you sell the stock in a shorter amount of time, you’ll face less favorable short-term gains rates, which are indexed against your overall earnings.
- If you inherit a stock and sell it before it increases in value, you don’t need to report any gains, as its acquisition cost and its sale cost are the same. Because of this, you can liquidate inherited stocks immediately without having to pay capital gains taxes on the transaction.