My kids have inherited $5 million worth of stock from their father (whose estate hasn’t been divided after 11 months), leaving them with about a 30% loss in value that they have no control over. Is there a way they can choose which stocks to sell and reap tax losses? It is their understanding that the Individual Retirement Account (IRA) withdrawal period has now been reduced from 10 years to nine years, making it even more onerous. Any help would be appreciated.
I’m sorry to hear of his passing. I am sure this is already a difficult time for you and your children, and I know that dealing with his troubled legacy and the issue of investment losses will not make it any easier.
There may be a lot of complexities at play here that I’m not aware of as I don’t know all the details of the estate, but I’ll try to explain some of the things you should keep in mind. that can help you decide how to proceed from here.
A financial advisor can help you make decisions about dealing with an inheritance and minimizing taxes.
Speak to the executor
First, I recommend that you speak with the executor of the estate and discuss any concerns you may have. There are several potential issues that can be resolved.
Without knowing anything further about the estate, I cannot say whether 11 months is a long wait for settlement. Simpler estates can be settled faster than complex ones, and more complex estates take longer. However, if you believe that the settlement is being delayed due to the executor’s laxity or inability, then this should be addressed. This is especially the case if the delay causes financial damage to your children.
Even if the delay isn’t due to something under the executor’s control, it can help to inform the executor’s decisions if you know what stocks your children would most like to sell. Only the executor or an appointed court administrator is authorized to sell estates.
Acquired IRA Distributions
Let’s also clarify their understanding of the inherited IRA distribution rules. Assuming your children are not minors, yes, under current law they have 10 years to withdraw money held in inherited IRAs. Specifically, the money must be withdrawn by the end of the tenth year following the year of death of the original account holder.
If their father died at some point in 2021, they have until December 31, 2031. If he died in 2020, they have until December 31, 2030.
Unfortunately, this clock starts at the time of the original account owner’s death, regardless of how long it takes to settle the rest of the estate and divide the assets.
Harvesting Capital Losses
It is unclear whether the shares in question are held in the IRA or in another account. This is important when it comes to figuring out the tax consequences and whether or not reaping losses is an option.
If the stock is held within the IRA, capital gains are already protected from tax. The flip side of that coin is that you can’t reap capital losses for a tax break either. What matters in this case is simply that when a distribution is received from the IRA, it is taxed as income to the recipient.
If the stock is in a taxable brokerage account, it’s a different story. In this case, capital losses can be used to offset capital gains. However, just because the stock’s value has fallen by 30%, it doesn’t guarantee that there are actually losses to harvest.
Be sure to check the stock’s base and understand if there are any unrealized losses.
If the inventories are in fact held in a taxable account so that capital losses can be harvested to reduce tax liability, and if in fact there are capital losses to be harvested, you still need to think about the best approach to harvesting those losses. If you sell the shares while they are still in the estate, the estate will receive the deduction for the capital loss.
That may or may not be the best approach. While estates have a much higher tax rate than most taxpayers — between 18% and 40% — the vast majority of estates are not subject to tax at all because of the current $12.06 million exemption amount. It could very well mean that you are reaping losses on an estate that owes no tax anyway.
Distribution in kind
If the estate instead transfers the shares in kind to your children, meaning that the estate does not sell the shares but distributes the actual shares to them, then their basis in the shares is most likely their fair market value on the date their father passed away. . That would be the case regardless of how much their father paid for them or what his base was. This is called a boosted base.
This potentially creates a tax-saving opportunity for your children. If the value of the stock has fallen by 30% since the death of their father, there is nothing they can do about it now. If they take distribution in kind, they might be able to sell and reap the 30% loss, which sounds like they were hoping to do in the first place.
I hope this provides some clarity and helps you think about your next steps. Inheritances can be very complex and tax rules often depend on small details. I highly recommend talking to a team made up of a lawyer, tax professional and financial planner who all have the necessary expertise to assist you.
Brandon Renfro, CFP®, is SmartAsset’s financial planning columnist, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAdvisor Match platform.
Tips for investing and retirement planning
If you have specific questions about your investment and inheritance situation, a financial advisor can help. Finding a qualified financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with up to three financial advisors serving your area, and you can interview your advisors at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you have a significant amount of capital, the inheritance tax can add up considerably. But you can plan ahead for taxes to maximize the legacies of your loved ones. For example, you can pre-gift parts of your estate to heirs or even set up a trust.
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