I have a tax question that I hope you can help me with. My father passed last year. About six months before he passed, he gifted me a variety of stocks that he had held for years. In total, I received about $100,000 worth of stocks. When my father passed, I inherited an additional $500,000 in stocks. Earlier this year I sold all the stocks and used the money to pay off debts. I paid off my house, my charge cards and a student debt that I incurred on behalf of my children. I have always done my own tax returns and I plan to do my 2018 return myself as well. My question is, as I do some year-end tax planning, what are the tax consequences of the sale of the stocks? I am confused as to what my cost basis is for the stocks I received. Hopefully, you can help me with it.
Darlene
Dear Darlene:
The tax consequences are different between the stocks that you received as a gift, and the stocks you received as an inheritance. First, let’s first talk about the $100,000 that you received as a gift. When you receive stocks as a gift, your cost basis is what is known as a transfer basis. In other words, your cost basis is the same as your dad’s cost basis. For example, if you dad had purchased the stocks in total for $60,000, that would be your cost basis. Therefore, when you sold the stocks you would have a $40,000 taxable gain ($100,000 – $60,000 = $40,000). Therefore, if you sold the stock for $100,000 you would pay capital gain tax on the $40,000. FYI, under the new tax law, your capital gain rate is now based upon your income instead of your tax bracket. If you are single and your income is less than $38,600, or if you’re married and your joint income is less than $77,200, you will actually pay zero taxes on long-term capital gains. Your tax rate will be 15 percent for single taxpayers whose income is up to $425,800 or $479,000 for joint filers. If your income is above these limits, your capital gain rate is 20 percent. In addition, high wagers may also be subject to an additional 3.8 percent on net investment income.
The tax treatment on the $500,000 that you received as an inheritance is totally different. Your cost basis is the fair market value of the stocks on your dad’s date of death. Therefore, if the value of the stocks you received as an inheritance were worth $500,000 at the date of death and you sold the stocks for $510,000, only the $10,000 would be subject to capital gains tax. The key difference between the tax consequences of a gift and an inheritance is the fact that in a gift you get a transfer basis, while on an inheritance you get a step-up basis based on the fair market value as of the date of death.
As a side note, I like what you did with the money. You used your inheritance to pay off debt, which generally I think is a good way of going. Being debt free gives you lots of flexibility into the future. Unfortunately, when many people receive an inheritance they look for ways to spend the money. You, on the other hand, looked for ways you could improve your financial health by paying down debt – congratulations.
Debt has a way of strangling people by preventing them from having any flexibility, and that is why I’m such a proponent of paying down debt wherever possible. Paying off charge card debt is a no-brainer, because by paying down that debt, your return is the interest you would have been paying. On a typical charge card, interest at a minimum, is 18½ percent. Therefore, since interest on charge cards is not tax deductible, when you pay down charge card debt you’re getting a guaranteed 18½ percent return on your money after taxes. I can’t think of any investment that would give you such a high return. Therefore, if you get an inheritance or a bonus, the first thing you should be doing is trying to improve your financial situation by paying down debt, particularly high interest, non-tax deductible debt.
Good luck!
If you would like Rick to respond to your questions, please email Rick at rick@bloomassetmanagement.com