Tax information needs when selling inherited mutual funds

[Live Free]

Please forgive my ignorance on taxes and capital gains. I promise I have looked on the IRS website and googled but now am just totally confused.

My 86 year old FIL recently passed in early February of this year. My BIL is the Executor of the estate and is going through the state-mandated probate process. I am trying to help him with all the paperwork, etc. as best I can, but it is a bit of the blind leading the blind. We have an attorney helping with all the court filings and legal paperwork, but some things are not handled/included with their services.

Which leads me to my tax information needs question. My FIL had a taxable brokerage account with 3 or 4 stock mutual funds as well as a money market account. My BIL will sell these and split the money between 4 siblings. My understanding is that there is a stepped-up cost basis for the stock mutual funds based on the date of death. So no capital gains or inheritance tax on that money for the siblings. However, there has been some gains in the value of the stock mutual funds since FIL's date of death in February. I am assuming the 4 siblings will have to pay taxes on those gains when they file their taxes? What information do they need in order to properly do that? Is there something they should ask the broker/FA for when they sell the mutual funds and distribute as cash payments to the 4 siblings?

Am I even asking the question correctly?!

 

[The Cosmic Avenger]

You are correct about the stepped-up basis. However, you may want to consult the estate lawyer. I can tell you that tax isn't due until the gains are realized, meaning the stock is sold, so I'm pretty sure either the estate or the four of you will be hit with short-term capital gains. Is there a reason your BIL can't direct the brokerage to divide the mutual funds up equally and transfer them in kind to the siblings? I still have a lot of the holdings my father left me; he was a very shrew investor, and I haven't needed to sell most of it. When I do sell positions in the taxable account, I pay LTCG, using the stepped up cost basis from when he passed away in 2016.

But if your BIL really wants to sell, then yes, some tax will be due, and I'm not sure legally if it is the estate that pays, or the heirs. I'm leaning towards thinking it's the heirs, as legally I believe each 1/4 of the account belonged to the siblings when he died, the BIL just hasn't distributed it yet.

In other words, I have no idea! Definitely a good question for the lawyer, although someone else here may have gone through this exact situation and may have a more definitive answer.

 

[RunningBum]

This Bogleheads thread might help:
https://www.bogleheads.org/forum/viewtopic.php?t=239393

It looks like the estate can sell the funds and distribute cash, and send a K-1 to heirs with the cost basis at death and proceeds at sale (and dates of both), from which you pay your taxes. Presumably the shares haven't grown that much that STCG isn't a big issue, but if it is you may just look at distributing shares so they can be held long term. If it is a large amount, it's probably worth paying extra for legal advice on it.

I see mention of using an alternate date for step up of 6 months later, but that seems to be only for estates large enough to owe an estate tax.

 

[kaneohe]

Inherited shares are automatically long-term Acquisition date is "Inherited"
https://www.hrblock.com/tax-center/income/investments/holding-period/

"Inheritances — Your holding period is automatically considered to be more than one year. So, when you sell the inherited stock, it’s subject to long-term capital treatment. This applies regardless of the actual holding period."

 

[RunningBum]

^^
Nice find! Now that you mention it, I do recall hearing that before.

 

[ERD50]

Inherited shares are automatically long-term Acquisition date is "Inherited"
https://www.hrblock.com/tax-center/income/investments/holding-period/

"Inheritances — Your holding period is automatically considered to be more than one year. So, when you sell the inherited stock, it’s subject to long-term capital treatment. This applies regardless of the actual holding period."

Thank you, I did not know that!

This actually does apply to us, as we had to liquidate a fund in my MIL's estate to free up cash to distribute to the grandkids (didn't seem worth the hassle to make sure they all had brokerage accounts so that we could transfer in-kind). Not a big number, but as I'm doing tax planning, the more accurate I can be the better.

-ERD50

 

[target2019]

Might be better choice if heirs can decide whether to sell all or take the funds in a taxable account. Of course if the funds are turkeys, then selling all is the better option.

 

[RetireBy90]

A lesson I learned from mom, she had her investments with Wells Fargo brokerage and had beneficiaries set up on the account. No probate, just had to provide a death certificate and the 3 of us sat down with account rep while she opened accounts for each of us. Then she did transfer in kind of 1/3 to each account. I gave instructions to sell all the holdings so I could integrate her gift into our AA. Same with her IRA and her Fido accounts. Easy for us, just had to sit for few minutes to provide needed info for the accounts.

My lesson learned is with beneficiaries no probate, and institution in both cases took care of all the work. Our accounts are all setup the same.

If you have real assets like a house or beach condo don’t work as easy.

 

[SecondCor521]

So no capital gains or inheritance tax on that money for the siblings.

As others have noted, there will be long-term capital gains (or losses, as the case may be) on the stock based on the price difference between date of death and date of sale, minus any costs associated with the sale (brokerage fees, SEC fees - which are usually small).

Vanguard will update their basis records to date of death valuations if the executor asks them to. I assume other major firms will do similarly. You probably have to provide a death certificate, but that is easy.

Inheritance taxes may or may not be due. I believe that the value of the stock as of the date of death would be included in FIL's estate. Depending on the size of the estate and the state in which he resided, there could be federal and/or state estate and inheritance taxes due. This is a separate issue and the step-up in basis at death doesn't really matter WRT estate/inheritance taxes as far as I know.

 

[swakyaby]

My four siblings are going through something similar as your BIL since my parents recently passed. There are taxable brokerage accounts at several different mutual fund companies. One company was difficult for my brother the trustee to deal with (due to the requirement of a medallion signature guarantee in an out-of-state financial institution), so he was tempted to liquidate the entire account and distribute the cash among the 4 beneficiaries. However, it would create a large tax liability. So instead, he is requesting the company provide a stepped-up cost basis on the date of death, then he is splitting up the shares in-kind equally. It does require a medallion signature guarantee to change ownership of the shares, but there is a way to get around this. There is a bit of paperwork from each brokerage to do this, and it helps to go over the correct way to fill out the paperwork with an account representative. This way, each beneficiary has more control over their taxable income.

Fortunate, California does not (yet) have state inheritance taxes. And I believe your state of Virginia also does not.

 

[sakowitzm]

Just one more tidbit of information that may be helpful to someone. When we talk about the price on the date of death --> for a stock or ETF, that's calculated as the average of the high and low on that date. Since mutual funds are only priced after the market closes, I'm not sure what the algorithm is for that. I suppose it's possible that it depends on the actual time of death. Before the market opens --> price is last close of the previous market day. After the market closes --> price is the newly calculated price. But I'm just guessing on this last part.

 

[Gill]

Just one more tidbit of information that may be helpful to someone. When we talk about the price on the date of death --> for a stock or ETF, that's calculated as the average of the high and low on that date. Since mutual funds are only priced after the market closes, I'm not sure what the algorithm is for that. I suppose it's possible that it depends on the actual time of death. Before the market opens --> price is last close of the previous market day. After the market closes --> price is the newly calculated price. But I'm just guessing on this last part.

Not a good idea to "guess" when giving tax advice. Actual time of death has nothing to do with valuation. The mutual fund close on date of death will determine valuation for estate tax and basis purposes.
Gill