Minimizing Capital Gains on Inheritance

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workingonit
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Minimizing Capital Gains on Inheritance

Post by workingonit » Mon May 07, 2018 12:01 am

Hello,

I inherited about 30 stocks recently with about $165,000 in capital gains based on the cost basis of when the first relative died (it was part of a trust that funded a spouse's lifestyle until they died, which was about an 18 year gap, hence the significant gains upon transfer to me).

I want to sell the stocks, pay taxes on the gains, and move the money into my simple index portfolio strategy. The simplest thing to do is sell all and pay the taxes as a married filing jointly couple at the 15% capital gains rate. Move on with my life. Depending on the online calculator I use (that indicate they have been updated for 2018), this means $30-45K in federal taxes - our gross income balloons and I think we get into AMT territory. State taxes don't change based on income.

I'm trying to figure out if we should and how to optimize the tax situation in a few ways:

1. Pay a zero capital gains rate: I retired in 2017 in my early 40s (long-time goal) and have zero income (my spouse works though) and if we file separately and I keep my income below $38,700 after standard deductions I can qualify for the zero rate. Three different calculators and a friend tax accountant verify this strategy - I can sell off about $40,000 in gains per year for 4+ years, though we lose some benefits of filing jointly. The savings range from $2500-5000 over the 4 years based on simple modeling with the calculators and a spreadsheet if I'm doing it right. But tax law can obviously change in 4 years and I have to monkey with these stocks for that time period. Selling off in equal amounts to maintain 20+ stocks for diversity as well (I get 25 free trades/yr).

2. Avoid AMT Thresholds: I don't know much about this frankly and whether things are linear as you go up.

3. Shift Charitable Donations: We currently donate about $10,000/yr to about 20-25 charities. If we instead donate the stock to one or more of these charities, it resets the capital gains cost basis to zero. And we would then stop or shift our charitable donations using taxed income to pay ourselves back. But I'm not sure how to optimize this versus the paperwork - probably donate to < 5 charities with a personal understanding that we are donating a larger amount in one year and forgoing equivalent donations in 4 future years?

Perhaps this is all too complicated for the tax savings it represents? Or you have other thoughts/ideas?

Our situation: My spouse is still working and earns about $96,500. We have one child. She has about $10,000 in qualified dividends per year; myself about $15,000. We have about $1500 in interest and $1000 in short-term gains annually split roughly evenly. The stock inheritance represents about 20% of our total portfolio so it's not critical to anything short-term. We have plenty of emergency cash, no debt other than low-interest mortgage (that I'm not paying off early on purpose), etc.

Thanks.

M

AlohaJoe
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Re: Minimizing Capital Gains on Inheritance

Post by AlohaJoe » Mon May 07, 2018 12:14 am

workingonit wrote:
Mon May 07, 2018 12:01 am
our gross income balloons and I think we get into AMT territory.
Is this still true under the 2018 tax laws? I was under the impression that AMT changed dramatically, though I haven't looked into it myself.

FWIW, I pay way more in tax than you and don't pay AMT. I wouldn't assume you pay AMT just because you have high income.
3. Shift Charitable Donations: We currently donate about $10,000/yr to about 20-25 charities.
This seems like the easiest path. You'd probably want to set up a Donor Advised Fund and pre-fund it with a few years worth of contributions. You can lots of advice on the interwebs (and Bogleheads) about DAFs. You probably aren't going to donate all of the stock to the DAF but if you pick the ones with the most capital gains you could reduce the overall taxable amount.

If it were me, I'd probably fund the DAF and then immediately sell (and take the tax hit) of whatever was left over and then diversify my portfolio the way I want. I mean, your own calculations say you're only saving about $5,000 if you do it the slow way.

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FiveK
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Re: Minimizing Capital Gains on Inheritance

Post by FiveK » Mon May 07, 2018 12:27 am

workingonit wrote:
Mon May 07, 2018 12:01 am
Our situation: My spouse is still working and earns about $96,500. We have one child. She has about $10,000 in qualified dividends per year; myself about $15,000. We have about $1500 in interest and $1000 in short-term gains annually split roughly evenly.
Based on that, for MFJ in 2018 you won't be anywhere near paying AMT, and would pay ~$26,200 tax on the $165K.

The majority of the LTCG will be taxed at 15%, with some at 18.8% due to the NIIT, per the personal finance toolbox spreadsheet.

Don't know how much MFS would cost.

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celia
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Re: Minimizing Capital Gains on Inheritance

Post by celia » Mon May 07, 2018 1:26 am

workingonit wrote:
Mon May 07, 2018 12:01 am
I inherited about 30 stocks recently with about $165,000 in capital gains...

... pay the taxes as a married filing jointly couple at the 15% capital gains rate. Move on with my life. Depending on the online calculator I use (that indicate they have been updated for 2018), this means $30-45K in federal taxes.
If you have $165,000 in capital gains and it is taxed at 15%, doesn't that mean the federal taxes are $24,750? Is there something besides the capital gains that increases on the tax return? If you were older, I could see more of your SS being taxed, but this doesn't apply to you. Do you lose a tax credit somehow?

The way to figure this out is to print out the front and back of the 1040 Form with and without the capital gains included. Compare each line to see what else changes.

inbox788
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Re: Minimizing Capital Gains on Inheritance

Post by inbox788 » Mon May 07, 2018 2:15 am

AlohaJoe wrote:
Mon May 07, 2018 12:14 am
This seems like the easiest path. You'd probably want to set up a Donor Advised Fund and pre-fund it with a few years worth of contributions. You can lots of advice on the interwebs (and Bogleheads) about DAFs. You probably aren't going to donate all of the stock to the DAF but if you pick the ones with the most capital gains you could reduce the overall taxable amount.

If it were me, I'd probably fund the DAF and then immediately sell (and take the tax hit) of whatever was left over and then diversify my portfolio the way I want. I mean, your own calculations say you're only saving about $5,000 if you do it the slow way.
DAF is a great suggestion, and highest capital gains is tax efficient, but I'd consider keeping some of the individual equities depending on what they are and their tax liability for future tax efficient opportunities. I'd first evaluate the need to diversify and whether you could handle some concentration risk. I'd be willing to take a small chance with the possibility the equity out performs the market and I get tax benefit in the future. Even if one fails, you might still break even over next best choice. List some of the top holdings and gains to see if they're bigger risks or smaller risks.

gotlucky
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Re: Minimizing Capital Gains on Inheritance

Post by gotlucky » Mon May 07, 2018 8:33 am

workingonit wrote:
Mon May 07, 2018 12:01 am
Hello,

I inherited about 30 stocks recently with about $165,000 in capital gains based on the cost basis of when the first relative died (it was part of a trust that funded a spouse's lifestyle until they died, which was about an 18 year gap, hence the significant gains upon transfer to me)

...

Our situation: My spouse is still working and earns about $96,500. We have one child. She has about $10,000 in qualified dividends per year; myself about $15,000. We have about $1500 in interest and $1000 in short-term gains annually split roughly evenly. The stock inheritance represents about 20% of our total portfolio so it's not critical to anything short-term. We have plenty of emergency cash, no debt other than low-interest mortgage (that I'm not paying off early on purpose), etc.
This was a credit shelter trust, correct? That would explain why you didn't get a 2nd step up. I ask because if it were a QTIP trust, it may qualify for a 2nd step-up.

When you say, "We have one child. She has about $10,000 in qualified dividends per year", I'm guessing you mean your wife (and not your child).

If you aren't familiar with UTMA accounts, check them out. New 2018 tax laws make these more favorable for realizing gains if you are willing to make irrevocable gifts to your child. Quick caveat: If you are worried about your child having access to the money at the age of majority or if you are planning on relying on financial aid for you child's education, you need to think long and hard about UTMA accounts.

Certainly, not all the 30 inherited stocks have equal gains. You may even have some losers in there especially if there were some newer investments or dividends had been reinvested. I'd probably just sell the ones with the lowest basis now and take the tax hit. If you have any with long-term losses (or any in your own portfolio), now would be a good time to balance those out with these gains. I'd then probably take the ones with high embedded capital gains and either 1) hold and slowly sell off at 0% cap gains rate, 2) donate to DAF, or 3) transfer to UTMA and have my children sell them at their 0% rate.

If I can't sell my long-term positions at the 0% rate, I prefer to just hold my individual stocks with long-term gains. I like the cost structure and the feeling that I'm getting an interest-free loan on the capital gains tax. Since it will be stepped up upon my or my spouse's death, it's like a free life-insurance policy. Besides, I always like having the option to realize gains when I inevitably incur losses that can't offset ordinary income in the near future. I harvest losses aggressively.

Tal-
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Re: Minimizing Capital Gains on Inheritance

Post by Tal- » Mon May 07, 2018 8:48 am

workingonit wrote:
Mon May 07, 2018 12:01 am

Our situation: My spouse is still working and earns about $96,500. We have one child. She has about $10,000 in qualified dividends per year; myself about $15,000. We have about $1500 in interest and $1000 in short-term gains annually split roughly evenly. The stock inheritance represents about 20% of our total portfolio so it's not critical to anything short-term. We have plenty of emergency cash, no debt other than low-interest mortgage (that I'm not paying off early on purpose), etc.
I'd be hesitant to weigh in without a better understanding of your current, and unique situation. A DAF is a great option for a lot of people and in a lot of situations, but it is also irrevocable. And, 20% of your portfolio is a big chunk!

At first glance, I think that putting all of this into a DAF today is too aggressive of a charitable act, and may put your personal finances at too great of a risk. I could be talked off this point, but that's my first-take.

Instead, I would consider manage your taxable income over the next 3-5 years and sell these stocks during that time. Or, you can keep them until you need to sell stock for any reason, and have these simply be the first ones to sell.

Lots of options here...
Debt is to personal finance as a knife is to cooking.

workingonit
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Re: Minimizing Capital Gains on Inheritance

Post by workingonit » Mon May 07, 2018 9:21 am

A few updates:

1. It is a QTIP. From what I've read and from what the trust accountant told me and the cost basis paperwork the trust brokerage gave me, the cost basis is the original relative's death, not the more recent spouse's. I'd be interested in knowing if there was an alternative interpretation.

2. To make an equal comparison, I created a spreadsheet to run filing jointly vs. separately (adding hers and mine together) across different sales strategies (sell off $40K, $80K, $160K), i.e. I'm only paying $645 in tax when I sell off $40K plus my dividends but my wife is paying on the $96,500 income and $10,000 dividends she is making and we lose some filing jointly benefits. I then standardize it by multiplying total taxes by 4 years to compare to selling off in 1 year. The strategy appears to be neutral on separately vs. joint when selling the whole thing off.

This is probably the most legitimate calculator I've been using:
https://turbotax.intuit.com/tax-tools/c ... terContent

3. Thanks for the suggestion on DAF.

4. We no longer qualify for itemized deductions unless we do something big on the charity side - have about 8 years left on the 15 mortgage and don't have huge state taxes.

gotlucky
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Re: Minimizing Capital Gains on Inheritance

Post by gotlucky » Mon May 07, 2018 10:07 am

workingonit wrote:
Mon May 07, 2018 9:21 am

1. It is a QTIP. From what I've read and from what the trust accountant told me and the cost basis paperwork the trust brokerage gave me, the cost basis is the original relative's death, not the more recent spouse's. I'd be interested in knowing if there was an alternative interpretation.
Perhaps someone more knowledgeable than I, which is pretty much anyone, will chime in.

My understanding is that if a QTIP Election is made when the first spouse dies (perhaps this is not your case), the QTIP trust assets are eligible for a 2nd step-up in basis upon death of surviving spouse. However, the QTIP assets are part of the estate of surviving spouse, so estate tax may apply.

Whereas a credit shelter trust, which is out of the estate of the surviving spouse, doesn't receive a step-up when passed to the remainder beneficiaries.

Edit: The brokerage isn't going to know if you receive a step-up or not. I think most QTIPs are funded with cash assets, so it would make sense as to why the basis used is near the date of death of the first spouse.

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FiveK
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Re: Minimizing Capital Gains on Inheritance

Post by FiveK » Mon May 07, 2018 2:33 pm

workingonit wrote:
Mon May 07, 2018 9:21 am
This is probably the most legitimate calculator I've been using:
https://turbotax.intuit.com/tax-tools/c ... terContent
That gets the same $26,232 difference due to the $165K LTCG as the spreadsheet mentioned previously, so there is a good chance that number is correct.

delamer
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Re: Minimizing Capital Gains on Inheritance

Post by delamer » Mon May 07, 2018 2:46 pm

In a similar situation, I sold some of the assets to achieve a more balanced portfolio. But I kept other assets to avoid a combined federal/state tax of 23% on their capital gains. One easy thing was to get rid of stocks with very small positions, just to minimize tracking headaches.

As someone mentioned earlier, it is likely that each stock has a different capital gains and it is worth picking and choosing what to sell (and when).

If you haven’t already done so, turn off any DRIPs.

Gill
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Re: Minimizing Capital Gains on Inheritance

Post by Gill » Mon May 07, 2018 2:54 pm

workingonit wrote:
Mon May 07, 2018 9:21 am


1. It is a QTIP. From what I've read and from what the trust accountant told me and the cost basis paperwork the trust brokerage gave me, the cost basis is the original relative's death, not the more recent spouse's. I'd be interested in knowing if there was an alternative interpretation.
If a QTIP election was made at the death of the first spouse, the trust would have been included in the estate of the second spouse and therefore you should have acquired a new basis at the death of the second spouse. You need to determine this because it could have a big impact on your basis.
Gill

workingonit
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Re: Minimizing Capital Gains on Inheritance

Post by workingonit » Wed May 09, 2018 11:05 pm

The CPA managing the trust has told me the QTIP is not eligible for a second step-up to the more recent death of my step-relative.

I've read the Will and QTIP formation for my relative and various QTIP articles online and I'm guessing that the QTIP was set-up without portability so that my step-relative would get income from the trust but wouldn't have legal authority to change the inheritance terms. If they did have legal control of the estate/trust, it would would allow the second cost-basis step-up to the more recent death but also put the assets at risk for the inheritance to be changed.

https://www.bosinvest.com/blog/estate-p ... elections/

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