When an estate sells stocks, the main tax consequence is capital gains tax. This tax applies only to the profit the stock makes after the original owner’s date of death. All the gains that built up during the owner’s lifetime are completely wiped away for tax purposes.
The central conflict comes from a powerful federal law: Internal Revenue Code § 1014, known as the “step-up in basis” rule. This rule resets the stock’s cost to its fair market value on the day the owner died, which erases decades of potential taxes. This creates a huge problem for the person managing the estate, who must now decide the best time to sell, balancing a massive tax break against the risks of the stock market.
For most families, this is the most important tax event they will face. While federal estate tax is rare, affecting only 0.04% of estates in 2020, capital gains tax from selling inherited assets is a far more common issue.
Here is what you will learn:
- 💰 How a special IRS rule can erase decades of taxable profits on inherited stock.
- ⚖️ The critical difference between an estate tax and an estate’s income tax.
- 📝 How to calculate the exact capital gain or loss when an estate sells shares.
- 🤔 The strategic choice between selling stock inside the estate or passing it directly to heirs.
- 🚫 The tax traps hidden in special assets like company stock options and retirement accounts.
The Two Worlds of Estate Taxes: What Every Executor Must Know
When a person passes away, their property enters a new legal status. This property is called an “estate.” The person in charge of the estate, called an executor or personal representative, has many duties, including handling taxes . It is vital to understand that an estate can face two completely separate types of federal taxes.
One tax is the federal estate tax, which is a tax on the total net worth of the person who died . This tax only applies to very wealthy estates. For 2025, the federal estate tax exemption is $13.99 million per person . This means if the estate’s value is below this amount, no federal estate tax is due.
The second tax is the estate income tax . An estate is a separate taxpayer in the eyes of the IRS. If the estate’s assets, like stocks or savings accounts, earn income after the owner’s death, that income is taxed. This is the tax that applies when an estate sells stocks for a profit.
Why the Estate Income Tax Is the Real Issue for Most Families
The estate income tax is reported on IRS Form 1041, U.S. Income Tax Return for Estates and Trusts. An estate must file this return if it earns more than $600 in gross income during the year. A profit from selling stock is considered income to the estate.
This distinction is the most important concept for an executor to grasp. The high federal estate tax exemption means most estates will never file an estate tax return (Form 706). However, many estates will sell assets to pay bills or distribute money to heirs, triggering the need to file an estate income tax return (Form 1041).
| Tax Type | What It Taxes |
| Federal Estate Tax | The total value of a person’s assets at the moment of death. |
| Estate Income Tax | Income generated by the estate’s assets after the person has died. |
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The “Magic Eraser” for Taxes: Understanding Step-Up in Basis
The single most important rule for inherited stock is the step-up in basis . This rule, found in Internal Revenue Code § 1014, is the foundation for calculating the tax on a sale. It acts like a magic eraser for taxes that built up over the original owner’s lifetime.
“Basis” is the price you use to figure out your profit or loss when you sell something. For stock you buy yourself, the basis is usually what you paid for it. When you inherit stock, the basis is not what the deceased person paid for it.
Instead, the basis is “stepped up” to the stock’s fair market value on the date the person died . This means all the appreciation that happened while the original owner was alive is never taxed.
Imagine your father bought 100 shares of stock for $1,000 many years ago. When he passed away, those same shares were worth $100,000. The estate’s new basis in that stock is $100,000, not the original $1,000.
How the Step-Up Wipes Out a Potential Tax Bill
This rule has a powerful effect. If the executor sells the stock for its market value of $100,000 shortly after the father’s death, the taxable gain is zero. The calculation is the sale price minus the new, stepped-up basis.
$100,000 (Sale Price) – $100,000 (Stepped-Up Basis) = $0 Taxable Gain
The $99,000 of profit that the stock made during the father’s life is completely forgiven by the tax system. This is a huge benefit for heirs. It allows an estate to sell assets without facing a large tax bill on decades of growth.
Calculating the Tax: The Simple Math Behind Selling Inherited Stock
When an estate sells stock, calculating the taxable gain or loss is a two-step process. First, you find the gain or loss. Second, you figure out the tax rate that applies to it.
The formula is simple: Sale Price – Stepped-Up Basis = Capital Gain or Loss.
If the stock’s value went up after the date of death, the sale results in a capital gain. If the stock’s value went down, the sale results in a capital loss. This loss can be used to lower the estate’s taxes .
The Automatic Long-Term Gain Advantage
A special rule makes selling inherited stock even more favorable. Any gain or loss from selling an inherited asset is automatically treated as long-term . This is true even if the estate sells the stock just one day after the owner’s death.
This is a major benefit because long-term capital gains have much lower tax rates than short-term gains . Short-term gains, from assets held one year or less, are taxed at high ordinary income rates. The automatic long-term rule ensures the estate always gets the lower tax rate.
The Hidden Catch: An Estate’s Brutal Tax Brackets
While the gain is always long-term, the tax rate itself can be a nasty surprise. Estates and trusts are subject to very “compressed” tax brackets. This means they hit the highest tax rates at much lower income levels than individuals do.
For 2025, an estate pays the top 20% long-term capital gains tax rate on income over just $15,900 . An individual taxpayer might not hit that rate until their income is over $500,000 . This creates a strong incentive for an estate to not hold onto income.
| 2025 Long-Term Capital Gains Tax Rate | Taxable Income Threshold for Estates & Trusts |
| 0% | Up to $3,250 |
| 15% | Over $3,250 up to $15,900 |
| 20% | Over $15,900 |
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*Source: *
An additional 3.8% Net Investment Income Tax (NIIT) can also apply to an estate’s investment income, pushing the top rate even higher . This tax kicks in once an estate’s income exceeds the threshold for the highest tax bracket, which is $15,650 for 2025 .
Three Common Scenarios: Seeing the Tax Rules in Action
Let’s walk through three of the most common situations an executor will face when dealing with inherited stock. These examples show how the rules work with real numbers.
Scenario 1: The Straightforward Sale at a Gain
An estate sells stock that has gone up in value since the owner died.
- The Situation: Maria passed away on February 1, 2025. She owned 100 shares of a company, which were worth $10,000 on that day. Her executor sells all 100 shares six months later for $12,000.
| Executor’s Move | Tax Outcome |
| Determine the stepped-up basis. | The basis is the value on the date of death: $10,000 . |
| Calculate the capital gain. | $12,000 (Sale Price) – $10,000 (Basis) = $2,000 Gain . |
| Determine the tax. | The $2,000 gain is a long-term capital gain . It falls into the estate’s 0% tax bracket (up to $3,250 for 2025), so the tax owed is $0 . |
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Scenario 2: Selling in a Down Market at a Loss
An estate sells stock that has lost value since the owner died.
- The Situation: Same as above, but the market goes down. Maria’s stock was worth $10,000 on her date of death. The executor sells it six months later for $7,000. The estate also earned $4,000 in interest income that year.
| Executor’s Move | Tax Outcome |
| Determine the stepped-up basis. | The basis is still the value on the date of death: $10,000 . |
| Calculate the capital loss. | $7,000 (Sale Price) – $10,000 (Basis) = $3,000 Loss . |
| Apply the loss to reduce taxes. | The $3,000 long-term capital loss can be used to offset other income . The estate uses it to reduce its $4,000 of interest income, leaving only $1,000 of taxable income. |
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Scenario 3: The Executor’s Choice: Sell or Distribute the Stock?
The executor must decide whether to sell the stock inside the estate or give the shares directly to an heir.
- The Situation: An estate holds stock with a stepped-up basis of $50,000. The stock is now worth $60,000. The only heir, David, is in a low personal income tax bracket. The estate itself is in the top 20% tax bracket.
| Executor’s Move | Tax Outcome |
| Option A: Estate Sells Stock | The estate sells the stock for $60,000, realizing a $10,000 long-term capital gain. The estate pays tax at its high 20% rate, owing $2,000. David receives the remaining cash tax-free. |
| Option B: Distribute Stock to David | The estate gives the shares directly to David (a “distribution in-kind”) . The estate recognizes no gain. David receives the stock with the estate’s $50,000 basis. If he sells it for $60,000, he pays tax on the $10,000 gain at his lower personal rate. |
In this case, distributing the stock to David is more tax-efficient. It moves the tax burden from the estate’s high tax bracket to the beneficiary’s lower one.
The Executor’s Playbook: Do’s and Don’ts for Selling Stock
Managing an estate is a position of high trust and legal responsibility. An executor is a fiduciary, meaning they must act in the best interest of the estate and its beneficiaries . Here are some key guidelines.
| Do’s | Don’ts |
| ✅ Do locate brokerage statements to establish the date-of-death value for the step-up in basis. | ❌ Don’t use the original purchase price of the stock. This is the most common and costly mistake. |
| ✅ Do check the will for specific instructions. Some stocks may be specifically promised to a certain heir and should not be sold . | ❌ Don’t sell everything immediately without a plan. Consider the estate’s need for cash and the tax situation of the beneficiaries. |
| ✅ Do get a separate tax ID number (an EIN) for the estate. The estate is its own taxpayer. | ❌ Don’t forget about state taxes. Many states have their own estate or inheritance taxes with much lower exemptions than the federal government . |
| ✅ Do consider distributing appreciated stock directly to beneficiaries in lower tax brackets. | ❌ Don’t ignore upcoming dividends. If a stock is about to pay a dividend, it may be wise to wait for that cash before selling . |
| ✅ Do work with a qualified tax professional and an estate attorney. The rules are complex, and mistakes can be costly. | ❌ Don’t try to time the market to maximize gains. An executor’s primary duty is to protect the estate’s assets from risk, not to be a stock trader. |
The Paper Trail: How a Stock Sale Is Reported to the IRS
Reporting the sale of inherited stock involves a clear sequence of IRS forms. The process is designed to track the money from the sale to either the estate or the beneficiaries who receive it.
- Form 8949, Sales and Other Dispositions of Capital Assets. This is where the sale of each individual stock is first reported . The executor lists the name of the stock, the date it was acquired (you simply write “Inherited”), the date it was sold, the sale price, and the stepped-up basis. The gain or loss for each sale is calculated on this form.
- Schedule D (Form 1041), Capital Gains and Losses. The totals from all the Form 8949s are carried over to this schedule . Schedule D summarizes all the estate’s capital gains and losses for the year to arrive at a final net gain or net loss.
- Form 1041, U.S. Income Tax Return for Estates and Trusts. The net gain or loss from Schedule D flows to the main estate income tax return, Form 1041 . Here, it is combined with any other income the estate earned, like interest or dividends.
- Schedule K-1 (Form 1041), Beneficiary’s Share of Income, etc. If the estate distributes income to beneficiaries, this is the form that reports it . The executor prepares a K-1 for each beneficiary, telling them their share of the income (including capital gains). The beneficiary then uses their K-1 to report that income on their personal Form 1040 tax return .
This system allows the estate to pass its income and tax liability through to the beneficiaries. The estate gets a deduction for the income it distributes, and the beneficiaries pay the tax, often at a lower rate .
Advanced Topic: The Alternate Valuation Date Election
For very large estates that owe federal estate tax, the executor has a strategic choice. Internal Revenue Code § 2032 allows the executor to value the estate’s assets six months after the date of death, instead of on the date of death . This is called the Alternate Valuation Date (AVD).
This election can only be made if it lowers both the total value of the estate and the amount of federal estate tax owed . It is a tool designed to provide relief if the market drops significantly after someone dies.
The Critical Trade-Off of Using the AVD
Choosing the AVD creates a major trade-off. While it can save a lot of money on estate taxes, it also resets the stepped-up basis to the lower value at the six-month mark. A lower basis means a higher potential capital gains tax when the asset is eventually sold.
| Pros and Cons of Electing the Alternate Valuation Date |
| Pros |
| Can significantly reduce the federal estate tax bill if asset values have fallen. |
| Provides tax relief for estates holding volatile assets in a declining market. |
| The estate tax savings are immediate and certain. |
| Can be used to reduce high state estate taxes in some states. |
| A simple “yes” or “no” election on the estate tax return. |
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The executor must carefully weigh the immediate estate tax savings against the future income tax cost. This decision requires a full analysis of the estate and the financial situations of the beneficiaries.
Advanced Topic: When the Step-Up Rule Doesn’t Apply
Not all inherited assets get a step-up in basis. Certain types of employee compensation are a major exception. These assets are called “Income in Respect of a Decedent” (IRD) . IRD is income the person earned but had not yet received or paid tax on before they died.
IRD assets do not get a step-up in basis . The beneficiary who receives them pays tax on the full amount, just as the original owner would have. This can result in a much higher tax bill than expected.
The Tax Trap of Inherited Stock Options and RSUs
- Non-Qualified Stock Options (NQSOs): When an heir exercises inherited NQSOs, the difference between the exercise price and the market value is taxed as ordinary compensation income, not a capital gain . This income also shows up on a W-2 form .
- Restricted Stock Units (RSUs): RSUs that vest because of the owner’s death are also IRD. The entire market value of the shares on the vesting date is taxed as ordinary income to the person who inherits them .
- Incentive Stock Options (ISOs): Inherited ISOs are also IRD and do not get a step-up in basis . The tax rules are complex, but exercising them after death often results in the gain being taxed as income, losing the special long-term capital gains treatment they might have had .
The key takeaway is that an executor must identify these assets early. They carry a built-in tax liability at high ordinary income rates, which is very different from regular inherited stock.
Frequently Asked Questions (FAQs)
- Can an estate sell stock right away? Yes. Any sale of inherited stock is automatically treated as a long-term capital gain for tax purposes, no matter how soon it is sold. This gives you the lowest possible tax rate.
- How do I find the stepped-up basis of a stock? The basis is the stock’s fair market value on the date of death. You can find this on brokerage statements from that month or by looking up historical stock prices online for that specific date.
- Does inherited stock in an IRA or 401(k) get a step-up? No. Assets in traditional retirement accounts are a major exception. Distributions from these inherited accounts are fully taxable as ordinary income to the beneficiary who receives the money .
- What if the estate sells stock for less than its stepped-up basis? This creates a long-term capital loss. The estate can use this loss to offset other capital gains. Up to $3,000 of any remaining net loss can be used to reduce the estate’s other income .
- Do I pay taxes when I inherit stock, or only when it’s sold? You pay no tax just for receiving the stock. Tax is only due when the stock is sold for a profit. The tax is calculated on the growth that occurred after you inherited it .
- Is it better for the estate to sell stock or for me to inherit it directly? It depends. If you are in a lower tax bracket than the estate, it is often better to inherit the stock directly and sell it yourself. This moves the tax liability to your lower rate.
- What is the difference between an estate tax and an inheritance tax? An estate tax is paid by the estate itself before assets are distributed. An inheritance tax is paid by the beneficiaries after they receive their inheritance. The federal government has an estate tax, not an inheritance tax .