One of the biggest mistakes we see with inheritances is the failure to step up the basis on an inherited asset prior to sale. Beneficiaries are often in a rush to get control of the asset, rather than going through a standard protocol and process, that will save them thousands of dollars in the end. See this example for a clearer understanding:
THE FACTS: Uncle Bob dies on January 15, 2024 with 2,000 shares of MSFT, valued at $776,940 ($388.47/share), in his Transfer on Death (TOD) Brokerage Account. He purchased this stock in 2015 for $50/share, or $100,000 total, and listed you as his sole beneficiary. Your family earns $225,000/yr of income.
The Inheritance Process That Ensues
- Bob’s account custodian receives your new account paperwork and transfers the MSFT stock into your account, reflecting the $100,000 cost basis and new $800,000 value. You sell all 2,000 shares at $400/share (or $800,000) to pay for private school and a new home.
- Tax time arrives and Turbotax calculates the tax owed on the sale as $201,600. This represents a Federal capital gain rate of 20%, Medicare surtax rate of 3.8%, and MA Capital Gain rate of 5%.
- You gladly pay the tax authorities. It is free money after all, and life goes on.
One might not understand is that MSFT’s cost basis should have been “stepped-up” to the current value on Uncle Bob’s date of death, or to $776,940 in the example, rather than the $100,000 basis reported on your tax return and account statement. This is a massive oversight. Rather than paying $201,600 to the IRS, you should have paid only $4,612 in total tax, calculated as $23,060 of gains x 20% (15% Federal and 5% MA Capital Gains rates). This is a $196,988 difference!.
The right advisory team and CPA should catch (and correct) this mistake by asking the right questions and assuming nothing. After all, we want to pay our fair share to the IRS, but we don’t want to leave a tip.
