“There was a lot going on and I have lots of regrets, but I can’t go back and change anything.”
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My children have inherited $5 million of stock from their father (whose estate has not yet been dispersed after 11 months) leaving them with a 30% or so loss of value over which they have had no control. Is there any way they could make a choice of which equities they should sell and harvest tax losses? It is their understanding that the 10-year individual retirement account (IRA) withdrawal period is now reduced to nine years which makes it even more taxing. Any help would be appreciated.
I’m sorry to hear about his passing. I’m sure this is already a difficult time for you and your children, and I know that dealing with his unsettled estate and the issue of investment losses don’t make it any easier.
There are potentially a lot of complexities at play here that I am not aware of because I don’t know all the details of the estate, but I’ll try to explain from a big-picture perspective some things that you should be aware of that might help you decide how to move forward from here.
A financial advisor can help you make decisions about handling an inheritance and minimizing taxes.
Speak With the Executor
First, I recommend that you speak with the executor of the estate and discuss any concerns you have. There are several potential issues this may help resolve.
Without knowing anything else about the estate I can’t say if 11 months is a long time to wait for settlement. Simpler estates can be settled more quickly than complex ones, and more complex estates take longer. If you believe, however, that the settlement is being delayed due to inaction or inability on the part of the executor then this needs to be addressed. That’s particularly true if the delay is causing financial harm to your children.
Even if the delay is not due to anything under the executor’s control, knowing which stocks your children would prefer to sell can help inform the executor’s decisions. Only the executor or an appointed court administrator has the authority to sell estate assets.
Inherited IRA Distributions
Let’s also clarify their understanding of the inherited IRA distribution rules. Assuming your children are not minors then, yes, under current law they have 10 years to withdraw any money held within inherited IRAs. Specifically, the money needs to be withdrawn by the end of the tenth year following the year of death of the original account owner.
If their father passed at any point during 2021, they have until Dec. 31, 2031. If he passed away in 2020, they have until Dec. 31, 2030.
Unfortunately, this clock does start at the time of the original account owner’s death regardless of how long it takes to settle the rest of the estate and distribute the assets.
Harvesting Capital Losses
It’s unclear whether the particular stocks in question are held within the IRA or in a different account. That matters when it comes to figuring out the tax ramifications and whether or not harvesting losses is an option.
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If the stocks are held within the IRA, then capital gains are already shielded from taxation. The other side of that coin is that you also can’t harvest capital losses for a tax benefit. What will matter in this case is simply that when a distribution is received from the IRA it will be taxed as income to the recipient.
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If the stocks are held within a taxable brokerage account, then it’s a different story. In this case, capital losses can be used to offset capital gains. However, just because the stock’s value has dropped by 30% doesn’t guarantee that there are actually any losses to harvest.
Make sure you check the stock’s basis and understand whether there are any unrealized losses to take.
Estate Taxes
If the stocks are in fact held in a taxable account such that capital losses can be harvested to reduce tax liability, and if there are in fact capital losses to harvest, you still need to consider the best approach for harvesting those losses. If you sell the stocks while they are still held within the estate, then the estate will get the deduction for the capital loss.
That may or may not be the best approach. While estates do have a much higher tax rate than most taxpayers do – running between 18% and 40% – the vast majority of estates are not subject to taxation at all due to the current exemption amount of $12.06 million. It could very well mean that you harvest losses against an estate that doesn’t have a tax liability anyway.
Distribution in Kind
If instead, the estate passes the stock to your children in-kind, meaning the estate doesn’t sell the stock but distributes the actual shares to them, then their basis in the stock is most likely their fair market value on the date their father passed. That would be the case regardless of the amount their father paid for them or what his basis was. This is called a stepped-up basis.
This potentially creates a tax-saving opportunity for your children. If the stock’s value has fallen by 30% since their father passed, then there isn’t anything they can do about that now anyway. If they take distribution in kind, they may be able to sell and harvest the 30% loss, which is what it sounds like they were hoping to do in the first place.
Next Steps
I hope this provides some clarity and helps you think about your next steps. Estates can be very complex and tax rules often hinge on minor details. I strongly encourage you to speak with a team that includes an attorney, tax professional and financial planner who all have the necessary expertise to help you.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAdvisor Match platform.
Investing and Retirement Planning Tips
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If you have questions specific to your investing and inheritance situation, a financial advisor can help. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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If you have a sizable estate, estate taxes could be hefty. But you can plan ahead for taxes to maximize your loved ones’ inheritances. For example, you can gift portions of your estate in advance to heirs or even set up a trust.
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My mother passed away in first quarter 2021, leaving me a designated beneficiary brokerage account and an IRA account.
The total amount of these accounts invested in stocks and ETFs was at that time $150,000. Since then, due to the market (or my poor management), those accounts are totaling around $122,000.
Can I liquidate those two accounts and take a tax write-off?
Mulling next move
Dear Mulling,
My condolences about your mother. Now, let’s make the best of the situation.
There’s a tax way to think about the approximate $28,000 loss gnawing at you. If you want to liquidate these inherited accounts, the tax code might help — but a nasty tax bite could be lurking if you aren’t aware.
There’s also an investing way to think about these accounts. Be easy on yourself about the losses, by the way. 2022 was tough for lots of portfolios and there’s still six months to see the full extent of 2023’s rebound. But if you close these accounts now, what’s the plan for where the money goes next?
Let’s start by distinguishing the different IRS rules at play with your inherited brokerage account and your inherited IRA.
There was a time when you could have deducted the losses on that inherited IRA, said Luis Rosa, founder of Build a Better Financial Future, where he he offers investment management and tax preparation services.
That would’ve happened by itemizing your deductions and taking advantage of a miscellaneous deduction, he said.
That changed with the 2017 Tax Cuts and Jobs Act, a sweeping tax code overhaul that included major changes for individual filers through 2025.
The law nearly doubled the standard deduction while reducing the ways people could itemize their deductions. A number of miscellaneous itemized deductions were temporarily repealed.
The “loss on traditional IRAs or Roth IRAs, when all amounts have been distributed to you,” was one example, the IRS said.
“Unfortunately, any losses in an IRA are gone and there’s no tax benefit to them,” Rosa said.
In the current set of rules, if you cashed out the inherited IRA, “all that would be considered taxable income as well, to add insult to injury,” he added. More specifically, Rosa said the distribution would count as ordinary income, which doesn’t get the preferential rates that apply to long term capital gains.
A sudden one-year income spike from the closed-out IRA could potentially push you into a higher tax bracket and have you facing a bigger tax bill that year, Rosa noted.
A better tactic would be gradually siphoning the account’s proceeds over the years to avoid a sharp income tax bill increase, he said. Beneficiaries have a decade to liquidate an inherited IRA. The time to close out the account finishes at the end of the 10th year after the death of the IRA owner, Vanguard notes.
Then there’s the brokerage account. Here, capital gains and loss rules are the key.
The losses from this account will offset any long-term capital gains you’ve taken elsewhere, Rosa said. If there’s still more losses after the offset, you can use them to reduce your income by up to $3,000. The rest of the losses can be carried forward to future tax years.
You could liquidate the IRA account in small gulps and you could sell the brokerage holdings and apply the capital losses there. You could also sell at a loss in small increments with the brokerage account too. Or you could play the waiting game and see if the investments turn for the better.
However you play it, there’s the next question: What’s next for the money?
Do you reinvest it back in the stock market?
If so, beware of an IRS wash sale rule that will disallow a capital loss if the seller buys the same, or nearly the same, security just before or just after the sale. The wash sale rule applies to the 30-day window before the sale and the 30-day period afterwards.
That’s a technical matter, but the general point is have a plan as you move on.
“If you are going to sell, know where it’s going,” said Scott Bishop, partner and managing director of Presidio Wealth Partners.
If newly-purchased securities are going in those existing accounts, Bishop said it matters what sorts of investments are inside those accounts.
Remember, when the IRA money comes out, it counts as ordinary income. So if you put a fast-appreciating asset like a stock in the account, it will balloon the income tax liability when the money eventually comes out, Bishop said. (And again, you have a 10-year deadline to clear out the IRA.)
A better move could be putting assets with smaller returns — like bonds — in the inherited IRA because smaller returns will translate to a smaller income tax hit at distribution, he said. Save any new stock investments for the brokerage account.
That’s where the capital gains rates can save you tax dollars on high-flying investments, Bishop noted. “You want to think of the tax nature about what you are doing,” he said.
But most of all, you want to think about what you are doing in the broadest sense. “Don’t sell until you have a plan to buy,” Bishop said.
Cashing out the holdings and then reacting to market swings is a strategy that’s asking for trouble.
“The emotional biases we have make it difficult to sit with cash. …. The market has a great way of making us look foolish,” Bishop said.
Got a tax question? Write me at: akeshner@marketwatch.com
Thanks for reading. I want to help you think more broadly about the issues that affect your taxes. I’m not offering tax advice, just an attempt to look at what the swirl of tax rules and economic conditions could mean for your wallet.
I’m here for the reader who faces their taxes with an air of resignation. You’re just not that into taxes, I get it. I was once that guy. Underneath the jargon, think of your taxes like a maze — with money at the end. Or a trap that you need to avoid.