Ask an Advisor: $5 Million Windfall

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 Specifically, the money needs to be withdrawn by the end of the tenth year following the year of death of the original account owner.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.

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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.

• 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.

• 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. A financial advisor can help you navigate paperwork.

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 [email protected] and your question may be answered in a future column.

Please note that Brandon is not a participant in the SmartAsset AMP platform, nor is he an employee of SmartAsset. He was compensated for this article..

Investing and Retirement Planning Tips

• 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.

• 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.

• Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

• Are you a financial advisor looking to grow your business? SmartAsset AMP helps advisors connect with leads and offers marketing automation solutions so you can spend more time making conversions. Learn more about SmartAsset AMP.

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