What Is Inherited Stock?
As the name suggests, inherited stock refers to stock an individual obtains through an inheritance, after the original holder of the equity passes away. The increase in value of the stock, from the time the decedent purchased it until their death, does not get taxed. Therefore, the beneficiaries of the stock will only be liable for income on capital gains earned during their own lifetimes.
- Inherited stocks are equities obtained by heirs of an inheritance after the original stockholder has passed.
- Any increase in value that occurs between the time the decedent bought the stock until they die, does not get taxed.
- Inherited stock is not valued at its original cost basis, which refers to its initial value, at the time of its purchase.
- When a beneficiary inherits a stock, its cost basis is stepped up to the value of the security at the date of inheritance.
Understanding Inherited Stock
Inherited stock, unlike gifted securities, is not valued at its original cost basis—a term used by tax accountants to describe the original value of an asset. When an individual inherits a stock, its cost basis is stepped up to the value of the security, at the date of the inheritance. In the eyes of the federal government, stepped-up cost basis is an expensive provision of the tax code, which only benefits wealthy Americans. Consequently, candidates for elected office often preach the idea of eliminating the stepped-up cost basis, in an effort to broadly appeal to middle- and lower-class voters.
History of Inherited Stock
The United States has taxed the transfer of wealth from a decedent's estate to their heirs since the passage of the 1916 Revenue Act, which complemented the existing income tax, in order to help finance America’s entry into World War One. Proponents of this legislation argued that taxing estates can help raise much-needed revenue, while simultaneously discouraging the concentration of wealth among a small percentage of individuals. Opponents of the estate tax, who frequently refer to it as the "Death Tax", argue that it’s unfair to tax someone’s wealth after it has already been taxed as income.
The taxation of inherited stock is a highly-contentious element in the debate over the taxation of inheritances, but it's also part of the conversation about capital gain taxation methodologies. For practical purposes, governments only tax capital gains after the underlying asset has been sold. This differs from income taxes, which must be paid annually. Proponents of the stepped-up basis exemption argue that capital gains should be taxed more lightly than income, in order to promote investment in the economy through increased consumer spending.
Inherited Stock and Estate Planning
Because heirs will not have to pay capital gains taxes on stock that are unsold at the time of a decedent's death, benefactors should resist the urge to sell off the equities they plan to bequeath to their heirs during their living years.
At the same time, heirs to stocks cannot claim a loss for losses incurred while the original owner was alive. Therefore, if a decedent purchased a share of stock for $100, then the value plummeted to $25 by the date they passed, an heir's cost basis would be $25, and that $75 loss may not be used to offset gains with other investments.
Example of Inherited Stock
Consider a person who inherited 100 shares from a deceased relative. The cost basis of these shares is equal to their value on the day of the owner’s death. In other words, taxes will be based on this new cost basis, as opposed to the original cost. After providing a death certificate, proof of identity, probate court order, and others, the heir can either transfer the shares into their account or sell the shares for the proceeds. Ultimately, this has the potential to save significant sums of money due to the tax loophole.