What Happens When You Inherit Stocks?

Inheriting stocks presents financial and tax considerations that can significantly impact a beneficiary’s future. The path an inherited stock takes, and its tax treatment, often depends on the type of account in which it was held by the original owner.

Inheriting Stocks in a Taxable Investment Account

When stocks are held in a standard brokerage account, their inheritance involves specific transfer and tax rules. Transfer of ownership often depends on how the original owner structured their account. If the account had a Transfer on Death (TOD) designation or was jointly owned with rights of survivorship, assets usually bypass probate, allowing direct transfer to the named beneficiary. Otherwise, stocks may become part of the deceased’s estate and go through probate, a legal process for validating a will and distributing assets.

A key aspect of inheriting stocks in a taxable account is the “stepped-up basis” rule. This rule adjusts the cost basis of the inherited stock to its fair market value on the date of the original owner’s death. For example, if a stock purchased for $10 was worth $100 on the date of death, the new cost basis for the beneficiary becomes $100. This adjustment can significantly reduce or even eliminate capital gains tax if the stock is sold shortly after being inherited, as any gain is calculated from this new, higher basis.

If the beneficiary holds onto inherited stocks before selling, future capital gains or losses are calculated using the stepped-up basis. For instance, if the stock’s value increases to $110 before being sold, the capital gain is $10 ($110 selling price minus the $100 stepped-up basis). Conversely, if the stock’s value declines to $90, a capital loss of $10 is realized. Beneficiaries can sell the stocks, hold them as part of their investment portfolio, or transfer them to another brokerage account, based on their financial goals and diversification needs.

Inheriting Stocks in a Retirement Account

Inheriting stocks held within retirement accounts, such as an Individual Retirement Account (IRA) or a 401(k), operates under different rules than taxable accounts. There is no stepped-up basis for these assets; instead, distributions are taxed as ordinary income to the beneficiary. The transfer process typically bypasses probate, with funds moving directly to an “inherited IRA” or “beneficiary IRA” established for the heir.

Inheriting retirement accounts involves Required Minimum Distribution (RMD) rules. For a surviving spouse, several options are available. A spouse can roll over inherited funds into their own IRA, treat the inherited IRA as their own, or maintain it as an inherited IRA subject to specific distribution rules. Rolling over funds allows the spouse to defer distributions until their own RMD age, typically 73, and combine it with existing retirement savings.

For non-spousal beneficiaries, the “10-year rule” generally requires the entire inherited account to be distributed by the end of the 10th calendar year following the original owner’s death. This means the beneficiary must withdraw all funds within that decade, though annual distributions are not required. Any distributions are taxed as ordinary income in the year received. Limited exceptions to the 10-year rule exist for “eligible designated beneficiaries,” such as minor children, disabled or chronically ill individuals, or beneficiaries not more than 10 years younger than the deceased, who may stretch distributions over their life expectancy.

Decisions regarding distributions from an inherited retirement account should consider immediate tax implications. Taking a large lump sum distribution in a single year could push the beneficiary into a higher income tax bracket. Spreading distributions over the 10-year period, or utilizing exceptions, can help manage the tax burden.

Key Considerations for All Inherited Stocks

Regardless of the account type, maintaining records is important. Beneficiaries should retain all documentation related to the inheritance, including the original owner’s death certificate, records establishing the fair market value of stocks on the date of death, and paperwork associated with ownership transfer. These records are crucial for calculating future capital gains or losses accurately and for tax reporting.

While income tax on distributions or capital gains is a primary concern, beneficiaries should understand estate tax. Federal estate tax is levied on the value of the deceased person’s estate before assets are distributed to heirs, but only if the estate’s value exceeds a certain threshold, adjusted annually for inflation. This is separate from any income tax a beneficiary might owe on inherited assets. Some states also impose their own estate or inheritance taxes, which can apply even if the federal threshold is not met.

Inherited stocks should be evaluated within a beneficiary’s overall financial plan and investment portfolio. Inherited stock often represents a significant concentration in a single company or industry, which can introduce undue risk. Considering diversification strategies, such as selling some or all shares to invest in a broader range of assets, can help manage risk and align the portfolio with personal financial goals.

Seeking professional guidance for inherited assets can be helpful. Financial advisors can help integrate inherited stocks into an investment strategy and provide insights on portfolio diversification. Tax professionals, such as Certified Public Accountants (CPAs) or enrolled agents, offer advice on tax implications, including basis adjustments, RMDs, and reporting requirements. An estate attorney can provide guidance on probate matters, trust administration, and legal aspects of asset transfer.