By Kaye A. Thomas
Current as of January 7, 2015
How to determine your basis and holding period for inherited stock.
You need to know the basis and holding period of any stock you inherit so you can report the correct amount, and correct category, of gain or loss when you sell the shares. The rules described here apply when the inherited stock was owned by an individual. Different rules may apply if the stock was held in a trust or a family limited partnership. You may need to consult a tax professional to learn the basis of stock you receive in these special cases.
Note: This page does not address the special rules for decedents dying in 2010. For a description of those rules, see Property Received from 2010 Decedents.
Inheritance is not income
As a general rule, cash or property you inherit from a decedent is not considered income. You don’t have to report it on your income tax return. Of course, if you later receive income from that property (such as dividends on stock) you must report that income.
Exception. An exception applies when the cash or property represents income in respect of a decedent, or IRD. You have IRD when you receive an amount, such as an IRA distribution, that the decedent would have had to report as income if received during his or her lifetime. An item in this category does not receive the basis adjustment described below and is included in the income of the recipient.
Net unrealized appreciation. Long ago the IRS ruled that when stock with “net unrealized appreciation” is distributed from a retirement plan, this portion of the stock value becomes IRD, and therefore does not receive a basis adjustment, if the owner dies while holding the stock. There is some reason to doubt the validity of this ruling, however.
Determining Your Basis
Your initial basis in stock you inherit is based on the fair market value of the stock on the relevant valuation date. In most cases (see exception below) the valuation date is the date of death. In tax lingo we say that the stock’s basis is stepped up (or stepped down) to the date-of-death value.
Example: Sally’s father bought 800 shares of XYZ stock many years ago for a total of $1,600. Sally inherited the stock when her father died. On his date of death, the value of the stock was $32,000. Sally’s basis in the stock is $32,000. If she sells it for $28,000, she has a loss of $4,000; if she sells it for $40,000 she has a gain of $8,000.
This tax rule provides a significant benefit to Sally. No one had to pay income tax on all that increase in value that occurred while her father owned the stock. Yet Sally gets the same basis as if she bought the stock for $32,000.
This rule can work the other way, though. Suppose Sally’s father bought the stock for $32,000, but it was only worth $1,600 when he died. Now the basis will be stepped down. No one will ever receive an income tax deduction for the loss of value in this stock while Sally’s father owned it.
Exception for alternate valuation date
There is a special rule under the estate tax that allows the executor to elect a different valuation date in certain cases. If the estate qualifies for this election, and the executor makes the election, the valuation date is six months after the date of death. The principal reason for making this election is to reduce the amount of estate tax that must be paid. But the election also has an effect on income tax, because it means you will now use the later date to determine your basis in the stock.
Example: In the example above, the stock had a value of $32,000 on the date of death. Six months later, the stock had a value of $27,000. If the estate qualifies for the alternate valuation date, and the executor makes this election, Sally will take the stock with a basis of $27,000.
In this example, Sally ends up with a lower basis, which means she may have to pay more income tax when she sells the stock. But the executor probably believed that the election saved an even greater amount of estate tax.
Determining the value
If the executor filed an estate tax return, then you should use the value reported on that return as your basis for the stock you inherited. Many times, the estate is too small to require an estate tax return. In this case, you should check stock listings or other sources to determine the fair market value of the stock on the date of death.
The holding period for stock received from a decedent is automatically considered long-term. It doesn’t matter how long the decedent held the stock, or how long the recipient held it. A sale of stock received from a decedent will always produce long-term capital gain or loss.