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Here in the US, my understanding is that if you inherit a stock, then eventually sell the stock, the capital gains tax is calculated as if you had bought the stock at the price that would have been its fair market value on the day you inherited it.

Assuming I'm understanding this correctly (and please correct me if I'm wrong), what would be the reason for this? It seems like an illogical and unfair tax advantage for the person inheriting the stock.

Is this just some kind of political deal that was made because of constituents' negative emotions about the so-called "death tax?" Or is there some kind of rational justification that I'm not understanding that is based on sound principles of economics or accounting?

closed as unclear what you're asking by Dilip Sarwate, Dheer, mhoran_psprep, Pete B., NL - Apologize to Monica Apr 9 '18 at 15:18

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    Beneficiaries never have to pay "death taxes" on the inheritances they receive: estate taxes (if any) are paid by the estate, and could reduce the size of the inheritances that the beneficiaries receive. – Dilip Sarwate Apr 6 '18 at 2:50
  • If the US is the same as (or close enough to) the UK in this respect, then my understanding is that all inherited assets (not just shares) have their basis set at the time of death (not when you "receive" the assets). I would guess the idea is that the person who died didn't benefit from any capital gain that might have been made since they bought the assets, and so no tax is due. For the inheritor, it seems fair that all that matters is the "present value" of what they inherit (they don't "get more" because the original owner bought it for a song). – TripeHound Apr 6 '18 at 7:13
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    Rich people write the tax laws. – Pete Becker Apr 6 '18 at 12:38
  • @DilipSarwate: The question is about capital gains taxes, not estate taxes. – Ben Crowell Apr 6 '18 at 20:19
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    You are the one who brought up "death taxes". If the inherited stock gets the original basis, then when the beneficiary sells the stock, there is typically a huge capital gain on which the beneficiary gets to pay capital gains tax. If the inherited stock gets the stepped-up basis, the beneficiary gets to pay capital gains tax only on the increase in value between the date of death and the sale. Which would you prefer as the beneficiary? With the step-up, the estate pays estate tax (but often no tax because of the $5M+ exemption) on the increase during the lifetime of the deceased. – Dilip Sarwate Apr 6 '18 at 21:33
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You just inherited a stock. How much did the person who bought it pay for it? How would you know? But it's easy to determine how much the stock costs the day of the inheritance. It's a definite day that can be recovered from public records and allows specific rules to determine which price on that day. But you almost certainly don't know when the decedent purchased the stock much less the price that they paid for it.

If they don't mark to market, then everyone would be stuck trying to figure out how much their loved ones, who just died, paid for a stock. So on what may be one of the worst days of their lives, they have to try to drag through all the paperwork to try to find the price paid for a stock that was bought at some prior time so that they can perpetuate that information for some time, possibly years away, when they need it. And of course, they have to know that they will need the information.

Or a simpler way to look at it is that the one who inherited it has only seen a gain since the inheritance. Why would they pay tax on gains from before they obtained the stock? It would make more sense to charge the estate the tax on capital gains before that. They have as much of the information as possible then.

While it's easy to view any tax break as applying more to the rich, it's worth noting that the people who would have the most trouble finding these records are the middle class (it seems unlikely that the poor have many stocks, although they may have wealthier relatives). The rich, who can afford to pay people to keep their paperwork for them, are impacted less by arbitrary requirements. Their employees keep track of that for them, particularly immediately after a loss.

The middle class are far more likely to try to do their own paperwork. And because they've never done it previously, they tend to make mistakes and miss things.

  • +1, but remember, no middle class person is going to be subject to..... wait for it........ The...... Estate...... Tax!!! Only because $11M is at least a few thousand dollars more than middle class. – JTP - Apologise to Monica Apr 8 '18 at 18:37
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    And this too is not an answer to "Why is capital gains tax on inherited stocks calculated based on the value of the stocks when inherited?" To which the only answer is that is what the law allows. For those like the OP who are distressed that beneficiaries are getting a break not available to ordinary people, the IRS is happy to accept the entire sale price as the capital gain (effectively, basis is 0) if the original purchase price is unknown, and there is no law prohibiting the OP from following this practice if and when he inherits some stock. – Dilip Sarwate Apr 8 '18 at 19:50
  • @JoeTaxpayer But middle class people are still subject to the capital gains tax on inherited property. What are you trying to say? It doesn't seem to have any relationship to the question or this answer. – Brythan Apr 8 '18 at 20:12
  • @Brythan - I see your point. But the basis is bumped up to the date of the inheritance. Due to the Estate Tax portion of our tax code. – JTP - Apologise to Monica Apr 8 '18 at 20:15
  • @DilipSarwate From the question: "Or is there some kind of rational justification that I'm not understanding that is based on sound principles of economics or accounting?" That's what I'm answering. The rationale behind the stepped-up basis. – Brythan Apr 8 '18 at 20:16
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The reason? As Pete noted, "Rich people write the tax code."

One can (and they do) argue about every bit of our tax structure. I live in a town where about 2/3 of our property tax goes to the school system. Zero kids, 1 kid, or 4, the property tax doesn't change. Fair? With my child off to college, I can move, or stay.

The tax code changes a bit over time. For estate tax, as far back as I recall, estates below the exemption amount (for 2018, $11.2M/person, up from $625K in 1998, when it first concerned me) benefit from no tax, and from the stepped up basis. The one exception was 2010, (when, as a Klingon would say "this is a good time to die) the tax itself was repealed, but there was no step up in basis. For the rich, this created an immediate windfall, but a paperwork burden for heirs that would extend until the asset was sold, or their own death.

The step-up is only one aspect of the estate tax discussion, it's not the only thing. Last year, at a $5.49M/person, fewer than 1 in 500 estates had any tax due at all. The doubling of the exemption makes it apply to far fewer.

It's fair to say that only the very rich would pay the tax, and of course only the even richer benefit from the cut, the increased exemption.

  • Your answer seems to be about estate taxes, but the question was about capital gains...? – Ben Crowell Apr 6 '18 at 20:18
  • They are inextricably linked. If another member can discuss the cap gain aspect while not mentioning estate tax, I will tip my hat to him/her. – JTP - Apologise to Monica Apr 6 '18 at 20:30
  • I don't understand. Why are they linked? Estate taxes seem to me to be totally unrelated to capital gains tax. – Ben Crowell Apr 8 '18 at 0:56
  • Well, because you asked about the cap gain that’s avoided when one dies. And the lines of code that offer a stepped up basis to one’s estate is contained in the same section as the rest of the tax treatment for estates. Of dead people. Linked. Cap gain taxes on the undead are unrelated to estate tax, but once dead, they (cap gain and estate taxes) are related. – JTP - Apologise to Monica Apr 8 '18 at 1:01
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    A +1 to this answer to offset the -1 from the OP, and a close vote on the question on the grounds that it is unclear what is being asked. – Dilip Sarwate Apr 8 '18 at 14:53

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