Albano Brokerage - Tips on inherited

There are many important issues when it comes to inherited stock, especially the step-up in basis rules. And when you're talking about inherited stock that has been in a 401(k), it gets even trickier.

Step-up is an estate tax concept. When a person dies, the general rule is that all property that was owned by the decedent (the dead person) is included in his estate at the value of that property on the date of death. That value is also known as the fair market value.

In some cases, where the value of the estate property has declined since the date of death, the property can be valued at six months after the date of death if that lowers the federal estate tax.

Because the estate of the decedent values the property at fair market value, a beneficiary who sells estate property is entitled to use the fair market value as his or her cost in figuring out the gain or loss on the sale of those assets.

This special treatment is known in tax talk as a "Step-up" in basis. The stepped-up value is the fair market value, as opposed to the original cost of the asset. Often, this step-up will drastically reduce the income tax your heirs will pay when they sell the estate property.

If your heirs sell right after your death, there will generally be no gain on the sale, because the cost used to figure gain or loss will be stepped-up to the fair market value at the date of death. If the asset is sold right after that, the selling price would be about the same, eliminating any income tax for your heirs.

However, here is the key: Not all estate property is entitled to a step-up in basis. Many assets, including inherited IRAs, do NOT receive such treatment.

The NUA rule

Now, I'd like to go a step further and talk about what happens when you inherit stock that's been in a 401(k).

Many workers invest in company stock in their 401(k)s or other company retirement plans. At retirement, this company stock enjoys a special tax break known in tax parlance as Net Unrealized Appreciation, or NUA.

NUA is the difference between the amount the stock was purchased for in your company plan and the value of that stock when you withdraw it from your plan. If the cost of your stock in the plan was $10 and it is worth $100 when you withdraw it from your plan at retirement, then your NUA is $90. This is the appreciation on the stock while it was in your plan.

So let's say that during your life, you never sold the stock and at your death the stock was worth $150.