Cost basis is certainly not something we think about on a regular basis, but it is critical to understand what it is when a loved one passes away. Here are answers to common questions about cost basis rules and implications.
What is cost basis?
- Simply put, the cost basis is the purchase price of your stock, bond, or mutual fund investment.
For example: If you purchased ABC mutual fund for $10,000 in a brokerage (non-retirement) account, this purchase price becomes your cost basis.
Why does this matter?
When you later sell your mutual fund, the cost basis helps determine your gain or loss on your investment, and subsequently, your potential tax liability.
For example: if you sold ABC mutual fund 2 years later for $12,000, your gain on the fund would be $2,000 and would be taxed at capital gains rates.
- Other items that effect the cost basis include stock splits, reinvested dividends, and return of capital adjustments. Brokerage firms are now required to keep track of cost basis, however, they might have missing or incomplete information on holdings that were acquired before the law took effect that requires custodians to track it.
What is the date of death step-up for cost basis?
- If a sole account owner passes away, the cost basis is increased to the value of the asset at the date of death.
For example: Let’s say your relative passed away on a weekday and the value of ABC mutual fund was $50,000 and their cost basis – the original purchase price — was $10,000. When the assets are inherited by you, your cost basis in the mutual fund becomes $50,000. The securities you inherit will also be treated as long-term holdings, which are taxed at more favorable rates than short-term holdings. If you then sell the mutual fund for $51,000—regardless of how long you held the stock—your taxable gain will be $1,000, but taxed at long-term capital gain rates.
- To step-up the cost basis, your broker may need documentation like a death certificate before they are able to make the change. Other variations of this process exist for stocks, mutual funds, and bonds depending on if someone passes away on a weekday, weekend, or holiday.
What is the date-of-death step-up if the brokerage account was jointly held?
- If the person who passed away owned an account with another person, or multiple people, the process is a bit different. In order to step-up cost basis, a broker would need to know who owned what percentage of the account. Often the executor of the estate, in conjunction with an attorney, would inform the broker what percent of the account should be stepped up. This might require a form to be submitted to the broker.
What is the alternative valuation date?
- The executor of an estate has the option of using the date of death value or the alternative valuation date when valuing assets for estate purposes. The alternative valuation date is six months after the date of death. This election is not commonly used because, in general, one would need to be subject to estate tax to elect the alternative evaluation date. In 2018, the Federal estate tax exemption is $11,200,00, so you would have to have an estate larger than that to be subject to estate taxes. Check your state’s laws as your state estate tax exemption may be lower than the Federal exemption in certain states.
For more specific questions about cost basis, consult your Financial Advisor, tax preparer, or the IRS website.
Elise Murphy, CFP®