Cost Basis Gone Bad

[tricky88]

I have an unusual situation, and I would like to get the opinion of this group's members.

My father passed away recently, and he had a huge amount of his taxable assets in energy funds and stocks. His positions had taken massive hits from this over-exposure, and despite having held some of these for a long time, he was in the red on almost all of them by 30% or so. (He refused to talk to me about the money nor would he listen to me about diversification.)

My parents lived in Arizona - my mother still does - which is a community property state. In a perfect world, she would get a nice stepped-up cost basis for these stocks and be able to re-balance while not having to pay taxes on gains.

But there are no gains. There are big losses. The step-up cost basis works against her big-time on this. Even more annoying, all of these stocks and funds are up since mid February when he died. So now that I can re-balance her portfolio, it looks like she will actually have to pay capital gains taxes on these assets which have all in fact lost a ton of her money.

A tax attorney and two brokers have looked at this and shaken their heads and said, yes unfortunately that's the way it is. We have no interest in just using the pre-death cost basis numbers and hoping not to get caught.

I have heard about the half step-up cost basis, where only half the assets get the new figure, but what I have found about AZ community tax law indicates the spouse gets the full "benefit" of cost basis. We are also apparently not allowed to just decline the cost basis step-up, which was my first hope.

My figures indicate that once I get rid of most of her energy assets and create a diversified portfolio she will have a tax bill of about $10,000 as opposed to having a nice huge tax loss that she deserves that she could carry over for the rest of her life.

Does anyone have knowledge of this situation that might be helpful? The tax bill of course won't be due for almost a year, but I did have her old broker (the one who encouraged my father's reckless behavior) do a date of death valuation of the assets to reflect the new cost basis.

Thanks in advance for your time.

 

[Gill]

I am not an expert in community property law, but my research indicates what you have already discovered, i.e., there is a full stepup in the situation you describe. Unfortunately, there is no election allowing the use of original cost rather than date of death values. Unfortunately, upon the sale of these assets you will have a taxable gain. Better planning would have had your father sell the assets at a loss during his lifetime, of course, but that is a lesson that can be used by others in a similar situation.
Bruce

 

[RunningBum]

Is there any way to sell them as part of the estate, and be able to use the losses on your dad's last income tax return? I'm doubtful especially since you had experts look at it, but that would seem to be the only chance. If the stocks are in your mother's account now there would be no way.


Most likely you just have to accept and move on, and the rest of us should take this as another reason to do tax loss harvesting.

 

[Gill]

Is there any way to sell them as part of the estate, and be able to use the losses on your dad's last income tax return?

No, that won't work. The securities still have a DOD value basis whether they are sold by the estate or later by a beneficiary.
Bruce

 

[Texas Proud]

This is a good lesson in keeping losses to a minimum if possible....

Sell and take the loss whenever possible and then buy back (or buy, wait the 30 days and then sell)...

Never carry large losses for a long time...


I look at my mom's account and will loss harvest if it is getting large.... heck, sometimes I do it when it is small just to have losses... that is when there are any... now the only possibility of a loss is the reinvested divies....

 

[LOL!]

The usual ways to avoid taxes on unrealized capital gains are simple:

1. Don't sell until you die.

2. Give away shares held long-term to charity and take a tax deduction, too, if you itemize.

3. Give shares to children who are in the 0% long-term capital gains tax bracket and have them sell the shares.

4. Try to get yourself into the 0% LTCG tax bracket and sell. This might mean selling over the course of a few years to keep oneself in the 0% LTCG tax bracket (i.e. 15% marginal income tax bracket or less).

 

[Animorph]

I thought there was an option to select cost basis on date of passing or something like 6 months (or up to 6 months) later. But it looks useless in this case:

"§ 2032 Election for Alternate Valuation[edit]
Section 2032 provides an alternate method of determining the property's new basis. If the property is not disposed of within six months of the decedent's death, the executor may elect to use the property's fair market value six months after the date of death BUT ONLY IF SUCH AN ELECTION RESULTS IN A DECREASE IN THE VALUE OF THE GROSS ESTATE.[2] If the executor does not so elect, or if the property is disposed of before the six months have passed, then the property will still assume a basis equal to its fair market value at the time of death."

https://en.wikipedia.org/wiki/Stepped-up_basis

Unless for some reason the total estate has decreased while the stocks have increased...

 

[Gill]

I thought there was an option to select cost basis on date of passing or something like 6 months (or up to 6 months) later. But it looks useless in this case:

"§ 2032 Election for Alternate Valuation[edit]
Section 2032 provides an alternate method of determining the property's new basis. If the property is not disposed of within six months of the decedent's death, the executor may elect to use the property's fair market value six months after the date of death BUT ONLY IF SUCH AN ELECTION RESULTS IN A DECREASE IN THE VALUE OF THE GROSS ESTATE.[2] If the executor does not so elect, or if the property is disposed of before the six months have passed, then the property will still assume a basis equal to its fair market value at the time of death."

https://en.wikipedia.org/wiki/Stepped-up_basis

Unless for some reason the total estate has decreased while the stocks have increased...

You're missing a few things. The estate also has to be subject to Federal Estate Tax and the alternate value reduces the value of the estate and the estate tax.
Bruce

 

[tricky88]

Thank you all for your replies. As always, this board is a wealth of information and experience. I had read about the 6 month reassessment and knew it wouldn't be of any help, but didn't understand the ins and outs. Now I do.

So, yes. Lessons learned by my mother that might be of help to someone else on the board down the road. Harvest those tax losses. Be aware of the consequences of a step-up - half or whole - if a loved one is sick. And of course diversify. Don't be 88 years old with 75% of your money in energy. Some trust would have gone a long way to avoiding these things, but my mother is healthy, and she has enough. Those are the most important things.