Tax Questions

Q. Could you explain how stock values are "stepped up" as a result of death? My father has a lot of stocks that he bought decades ago, and I'll be inheriting them when he dies.

A. Getting a stepped-up cost basis on inherited stock allows you to save taxes when the stock is sold.

For instance, if your father bought a stock at $10 a share, and it is now worth $100 a share, when he sells the stock, he will owe a capital gains tax on the $90 the stock has appreciated. If your father gives you the stock before his death, the gift will be valued at $100 a share, but you will take his cost basis of $10 a share. That means you will owe a capital gains tax when you sell the stock.

If your father waits to give you the stock until after his death, the stock will be valued in his estate at $100 a share, and you will have a new cost basis of $100. Your father's $10 cost basis gets "stepped-up" to $100 as a result of his death. This is true even if your father's estate is not required to file a federal estate tax return. When you later sell the stock, you will only owe capital gains if the value of the stock is higher than $100.

If your father is married, rather than leaving the stock to you, your father might leave the stock to his wife (presumably, your mother). In that case, your father and mother would probably own the stock as community property, with each owning one-half of the stock. Upon your father's death, your mother will not only get a stepped-up cost basis on your father's one-half of the community property stock, but she will get a stepped-up cost basis in her half of the stock as well. This is a benefit which is generally available only in community property states.

There are two exceptions worth noting. First, after your father's death, if his estate owes estate taxes, it is possible to value the stock six months following his date of death. If the stock is worth less at that time, you can use this lower value as a way to pay less estate taxes. But if you do, the basis in the stock is also the lower value--not the higher date of death value.

Second, if you own $20,000 worth of stock that you purchased for $1,000 years ago, you may be hesitant to sell the stock because you don't want to pay capital gains taxes (typically 20% of $19,000, or $3,800). Your idea may be to give the stock to your father, who is very ill and near death, and then have him leave it to you when he dies, thereby getting a stepped-up cost basis. As you might expect, the IRS doesn't like this, and there is a rule which says if your father dies within one year of being given your stock, then you receive the stock with your old cost basis. If your father makes it more than a year, then you do get the stepped up cost basis.