Key Takeaways
- Under IRS Publication 551, an heir’s cost basis in inherited property is generally its fair market value on the day the owner died.
- A retiree who bought stock for $100,000 that’s now worth $500,000 would report a $400,000 gain by selling, but an heir who sells at the same value reports none.
- Wes Moss told a Clark Howard Podcast listener this week that the only way to avoid taxes on appreciated assets is never selling them.
- Selling during life can still make sense for a retiree who needs the cash, has too much in one stock or holds a loser.
If you’ve owned a stock or a fund long enough to watch it multiply, you know the trap one listener brought to financial advisor Wes Moss on the Clark Howard Podcast this week. The listener called it “The Hotel California”: with direct indexing, investors “check in, but they don’t check out without taking enormous capital gains taxes” to get back into plain ETFs.
Moss pointed out that an ETF that grows tenfold leaves you in the same spot. He offered exactly one way out: “There’s no way to avoid taxes when your assets appreciate, except for never selling them.”
That’s a frustrating answer if you need the money, and a terrific one for whoever inherits your shares.
Check in, and never check out
Moss’s own example ran from $100,000 to $1 million, but plenty of retirees are sitting on smaller winners, and they face the same choice. So let’s take a hypothetical retiree who bought stock for $100,000 years ago and has watched it grow to $500,000.
If the retiree sells today, they report a $400,000 capital gain (the sale price minus what they paid) and owe tax on it.
If they hold it for life, the IRS treats those shares very differently. Its Publication 551 says the basis of inherited property is generally its fair market value on the day the owner died. The heir starts from that value, so the gain built up before then isn’t taxed when they sell.
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Zero gain for the heir
Now let’s say the retiree never sells. When they die, the heir’s basis resets to what the shares are worth that day. If the shares are still worth $500,000 when the heir sells, the sale price and the basis match, and the taxable gain is $0. Had the retiree sold a week before, the whole gain would have been taxed.
Same shares, same price, and the whole gain goes untaxed.
The heir’s basis is set on the day of death, though, so the heir pays tax on any rise after that when they sell.
When selling still makes sense
Of course, you can only hold forever if you never need the money. Moss told the listener that anyone who taps an appreciated account pays tax on the gain unless losses elsewhere offset it.
That’s his case for direct indexing. Moss said a tax-loss harvesting account on that same climb to $1 million may have built up $300,000 to $400,000 of losses along the way, so the owner can get at the money in a much more tax-efficient way. He said you still pay some tax that way, but you can get at more of the money tax-free.
Concentration is another reason to sell. If that one stock is most of a retiree’s savings, holding it for the step-up means betting the retirement on a single company. Paying some tax to spread the money around can be the better trade.
A stock that’s fallen below what you paid is also worth selling while you’re alive. The heir’s basis would be its lower value at death, so the loss would never get used. If you sell it during your life, the loss can offset gains elsewhere, the same trade Moss described.
Sometimes the best move is no move
The way I see it, if you don’t need the cash and one stock isn’t swallowing your portfolio, Moss is right: the smartest tax move on a big winner is often to leave it alone for your heirs.
Of course, I’m counting on the step-up staying on the books. It has no end date today, but Congress can always change it.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. Our analysis might not include recent company news or important updates. TIKR has no position in any of the stocks mentioned. Thank you for reading, and happy investing!
