Make sure your estate documents reflect your wishes
Dear Dan,
We have some stocks in a joint account with rights of survivorship that we’ve held for decades. A friend tells me the taxes would be better if we just held it until one of us dies instead of selling it now. Is that true?
— Curious in Phoenix
Dear Curious,
That could be true because you live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin). If the account is considered community property, which is likely, when one of you dies, the survivor will get a full “step up in basis” on the assets.
When you sell shares of stock, you incur a gain when the proceeds of the sale exceed your cost-basis. Cost-basis is basically the purchase price of the shares sold adjusted for splits and other corporate restructurings, if applicable. When you sell shares of certain inherited assets, you do not use the purchase price of the shares to calculate the gain. Instead, you use the value of the shares at the date of death.
For example, let’s say your shares of XYZ company were bought 30 years ago for $15,000 and are worth $100,000 today. If you sold it, you would have an $85,000 gain. Since you held the shares more than 12 months, the gain is taxed at the long-term gain rate, one of the more favorable rates in the tax code.
If, however, you die today, your wife’s basis will be $100,000 not $15,000. The basis has been “stepped up.” If she sold it next week for $102,000, she would have just a $2,000 gain. That gain is taxed at the long-term capital gain rate even though she inherited it only a week before the sale.
I want to highlight a few of the many things to consider about the step-up rules.
First, the step-up rules do not apply to holdings in IRAs, Roth IRAs, retirement accounts like 401(k)s, or other tax deferred accounts.
Second, if not in a community property state, the survivor in a joint account with rights of survivorship (JTWROS) would only get a 50% step up. To get a full step up for the survivor in a separate property state, the assets must be retitled into just one person’s name. This change of ownership triggers its own set of issues.
Individual accounts are owned by the individual. If one transfers the shares into an account in just one of the joint owners’ names, the other person no longer has any ownership rights to the shares. Unlike a JTWROS account, individual accounts are subject to probate. Also, to prevent “deathbed transfers” the account retitling must be done more than a year before the owner dies for the holdings to get a step up in basis. Additional planning is needed to address these factors.
Also, just because a stock has done well for you doesn’t mean it always will. I’ve seen a lot of people hold on to a longtime winner because they didn’t want to pay taxes on the gain and thought the company was rock solid only to see the stock price collapse. In many cases, they were left with less than if they had sold and paid the taxes. If a highly appreciated asset represents a large part of your net worth, such a decline can be catastrophic. Sometimes paying some tax is a good trade-off for lowering risk via diversification.
Bottom line is that regardless of which state law applies, good planning is needed to make smart use of the step-up rules. You should consult your adviser and retain an attorney to make sure your estate documents and account titling reflect your wishes and use these rules to your heirs’ advantage.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.
Originally published on MarketWatch. Read the original article here.