Does it matter if you inherited an asset or were gifted the asset? The answer is yes. The reason is tax implications and basis. Basis is the price paid for the asset. For real estate it includes the purchase plus any improvements to the property. For stock, mutual funds, exchange traded funds (ETFs) and bonds, it is the purchase price plus the commission.
For a gift, the original basis follows the asset. So if $X was paid for the asset, the basis stays at X when gifted. For an inherited asset, the basis resets at the date of death (or 6 months later) of the person leaving the inheritance. Many people inheriting assets choose to sell as soon as possible to minimize the amount of capital gains taxes paid.
Jia “got” shares from her Dad. Her father had bought shares every paycheck from the company he worked for as a young man. Her father paid anywhere from $0.64 per share to $2.34 per share.
Dad’s Average Cost Basis per share: $1.29 Fair Market Value (FMV) at date of gift per share: $70.81 FMV at date of Dad’s death per share: $89.39
Gifting: Dad gifts the shares while he is alive and his basis goes along with those shares. Jia sells the shares 10 years later when the FMV is $121.34, so her capital gain is $120.05 and she pays capital gains tax. If she had sold immediately on receiving the gift, her capital gain would have been $69.52 per share.
Inheritance: When Dad died, Jia inherited the shares from a non-retirement account. When she decided to sell 10 years later, the share price was $121.34. Jia’s basis is the value of the shares on the day her dad died. Her basis is $89.39 per share while her realized capital gain is $31.96 per share. She will be paying capital gains tax on the $31.96 per share. If Jia had decided to sell immediately after inheriting, and the stock price had not changed, her capital gain would have been zero.
Think of the tax implications as you inherit or are gifted assets. In addition, consider them as gift assets or write your estate plan. Decisions you make now can affect those who will inherit later.