When an individual dies, the executor is faced with an important decision that has the potential to impact the taxes owed by the estate and its heirs.¹
The executor will have the option of valuing the estate on the date of death, or on the six-month anniversary of death — the “Alternate Valuation Date.”
Pick a Date
It may seem like an obvious decision and simple choice, but it’s not. Here’s why.
For estates with substantial holdings in stocks, the use of the Alternate Valuation Date may be an appropriate approach if the executor believes stock prices will be lower than they were on the date of death.
When heirs inherit assets, such as stocks, they may receive a step-up in the cost basis if the value of the asset is higher than it was when the original owner acquired it. The heir’s valuation is reset to either the value on the date of the owner’s death — or the value on the Alternate Valuation Date — whichever is chosen by the executor.
Let’s take a look at a hypothetical example. Say Dad bought Out of Date Technologies at $10 per share several years ago. At his death, the stock was worth $35. The executor used the Alternate Valuation Date and six months later, due to market movements, the stock was worth $28.
His heir, Julie, will inherit this asset and receive a step-up in the cost basis to $28, the value declared by the estate. Let’s now assume that Julie sells the stock a short time later at $35.
If the estate had used the value on the date of death — $35 — she might not have owed capital gains tax, since she would have been selling the stock at the same price as her cost basis. But, since she received the stock with the lower cost basis — $28 — because the executor chose the Alternate Valuation Date, capital gains tax on the $7 per share gain may be due.²
In this example, the estate saved money by electing the Alternate Valuation Date, but the heir was exposed to a lower cost basis and the prospect of paying higher capital gains tax in the future.
Consider & Balance
As the executor thinks through this balancing act, he or she should consider the relative prevailing tax rates for the estate and for the heirs to ascertain what approach may result in the most efficient transfer, net of taxes, to the heirs.
Keep in mind the information in this article is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation.