Taxes on Investments Received as a Gift or Inheritance
Say you received some shares in a utility company from your grandmother, and now you want to sell them to invest in oil-company stocks. Calculating your tax bill is a little more complicated than if you had bought the shares yourself. But, it's still not as tough as brain surgery, or even a Roth IRA unconversion. Here's how to figure it out.
For inherited shares, the crucial bit of information is your benefactor's date of death. The general rule is your basis equals the market value of the shares on that day. Unless the value is conveniently listed on the estate-tax return, you won't have any "official" notification of this amount. So you may have to make a trip to the library to access microfilm copies of newspaper stock tables. Take the average of the high and low prices for the date of death. You then have to account for any subsequent capital changes like stock splits, spinoffs, mergers and the like.
There's one exception to the date of death rule. If the executor chooses to value the estate's assets on the "alternate valuation date" for estate tax purposes, your basis will be the value of the shares on that date. The alternate valuation date is either: (1) six months after the date of death or (2) if earlier, the date the shares were distributed to you, the heir. Why would anyone choose the alternate date? Because it reduces the estate tax hit if the decedent's portfolio declines in value within six months after his demise. This is a good thing for the executor (maybe you) to know. However, if the estate doesn't owe any federal estate tax, the alternate valuation-date rule is not available.
OK, now you know the basis of your inherited shares, or at least how to figure it out. If your sale will result in a profit, it automatically qualifies for the 15% maximum rate on long-term capital gains (for sales after May 5, 2003), regardless of how long the inherited shares were actually owned by the decedent or you. If you sell at a loss, it will be a long-term capital loss.
In filling out Schedule D, enter "inherited" in the space for the acquisition date of the shares. Don't enter the date you actually received them, because that could make it look like your holding period was too short to qualify for long-term capital gain treatment.
Stock Received by Gift
Here things get a little tricky. If you sell for a gain, you take over the donor's basis in the stock he so generously gave to you. In this case, your holding period includes the donor's duration of ownership for purposes of qualifying for long-term capital gain treatment. So in filling out Schedule D, use the donor's acquisition date as the date you acquired the shares. Of course, your friendly donor may have no record of either the cost basis or the acquisition date. If this is true, you'll need to do some investigative work to uncover that information, plus account for any capital changes before figuring your gain.
When you sell for a loss, your basis is the lower of: (1) the donor's basis or (2) the fair market value on the date the stock was given to you. If the fair market-value rule applies, your holding period begins on the date you received the shares rather than on the earlier date the donor acquired them.
If you sell for a price between the fair market value on the date of the gift and the higher donor's basis figure, the deal is a wash as far as the IRS is concerned. You have no taxable gain or loss.
For example, say you received stock worth $20 per share on the date of gift. The donor's cost basis was $30 per share. If you sell for more than $30, you have a capital gain equal to the difference between the sale price and $30. If you sell for less than $20, you have a capital loss equal to the difference between the sale price and $20. If you sell for between $20 and $30, it's a wash. In filling out Schedule D when the wash rule applies, simply enter the same amounts for your basis and the sale price.
One last thing. In the relatively unlikely event that your donor paid gift tax when she presented you with the shares in question, you may get to adjust your basis upward. The increase is equal to the gift tax attributable to any stock price appreciation occurring before the gift. It takes some mathematical gyrations to determine the exact amount of gift tax caused by the appreciation. You may want to consult a tax pro if this rule applies to you.