Stepped-up Cost Basis for Inherited NUA Stock for Surviving Spouse?

[taxnerd97]

Hi, Does anyone know how to calculate the Stepped-Up cost basis & what are the resulting LT Capital Gain calculation for the following NUA stock sale situations (items 5a-5c below):

1) Original Cost Basis of Company Stock in a 401(k): $20
2) At time of distribution out of 401K & into taxable brokerage acct: FMV $150 (NUA=$130).
3) No NUA stock was sold prior to father's death 2+ yrs later
3) At date of death (DOD), FMV of stock = $250, surviving spouse inherits all the NUA stk (in-kind), currently reported as uncovered shrs in her new brokerage acct with $250 stepped-up basis (which we know is wrong...)
4) Is there a stepped up-cost basis for the surviving spouse/heir, and if so, what would it be? Is there a basis step-up allowed for the stock appreciation from distribution date to date of death, calculated as: (250-150)+20= $120 new stepped-up cost basis for the NUA stock?
5a) If yes, what happens if NUA stock is sold a year after DOD for $200? Is the final LT Capital Gain calculated as $200-$120 = $80 (report LT CG for sale of NUA stock at LESS THAN original deferred NUA amount of $130)?
OR.....
5b) Do you have to maintain/recognize the original NUA amount on stock sale (since stk didn't fall below original $150 FMV at distribution??)and still report up to $130 as LT CG on the sale of stock at $200? Calculate LT CG as $200-$70 = $130 (impute a stepped-up cost basis #?)
OR....
5c) Is there absolutely no basis step-up allowed for inherited NUA stock, so LT CG would be calculated as $200-$20=$180?

Based on what I have read elsewhere, I think #5a (or maybe #5b...) is the right answer, but I can't find anything official (in IRS regs, etc.) to confirm it. Neither brokerage co. nor current CPA is familiar with inherited NUA stock basis calculations. Thanks in advance for any help you can provide with this issue!

[cas]

Based on what I have read elsewhere, I think #5a (or maybe #5b...) is the right answer, but I can't find anything official (in IRS regs, etc.) to confirm it.

I am not a lawyer nor an accountant, and I know nothing about how NUA works, but several reasonably reliable sources say that NUA is considered "Income In Respect of a Decedent." (***See note below). Given that, is this Code of Federal Regulations section maybe what you are looking for?

§ 1.1014-1 Basis of property acquired from a decedent.

(a) General rule. The purpose of section 1014 is, in general, to provide a basis for property acquired from a decedent that is equal to the value placed upon such property for purposes of the federal estate tax. Accordingly, the general rule is that the basis of property acquired from a decedent is the fair market value of such property at the date of the decedent's death [ . . .] <---[so this is the "step-up basis" clause, but it has an *exception* for "Income in Respect of a Decedent" (see below)]

[. . .]

(c) Property to which section 1014 does not apply. Section 1014 shall have no application to the following classes of property:

(1) Property which constitutes a right to receive an item of income in respect of a decedent under section 691 [ . . .]

Again, I am not a lawyer nor an accountant, and the real lawyers and accountants may show up here and tell me to quit playing one.


***Note on whether NUA is income in respect of a decedent:

So then that gets into whether NUA is considered "Income in Respect of a Decededent" (IRD). When it gets down to nitty-gritty details, what is and what is not IRD gets foggy, and I don't know enough about NUA to know. The long section on types of IRD in IRS Publication 559 might provide insight. For an unofficial source, the Boglehead's wiki article on Net Unrealized Appreciation says that NUA *is* considered IRD.:

Beneficiaries of a retirement plan can also take advantage of the NUA rules. The IRS considers this to be income in respect of a decedent (IRD). The NUA is taxed at capital gains tax rates when sold, and the beneficiaries get to take a deduction on any estate tax attributable to the NUA.

If the NUA is distributed and held until death, the beneficiaries do not receive step up valuation of the NUA (it still retains its character as NUA and becomes income in respect of a decedent taxed as a long term capital gain). Any appreciation in the stock beyond the NUA does qualify for stepped up valuation.

Michael Kitces, in his article on how something called the IRD Deduction applies to inherited IRAs, also mentions that NUA is considered to be IRD:

And notably, in the end the IRD deduction applies not only to inherited IRA accounts, but also other employer retirement plans, inherited non-qualified annuities, employer non-qualified stock options, deferred compensation, employer NUA stock, and more!

[Geologist]

To reinforce the remarks by cas, this article by Michael Kitces clearly states that "the NUA gain will eventually be taxed, as it is not eligible for a step-up in basis at death (under Revenue Ruling 75-125)."

See
https://www.kitces.com/blog/net-unreali ... sop-plans/

If you search for 75-125, you will see the exact spot in the article.

That would imply (based on the rest of the article) that the FMV at the time of the distribution ($150) establishes the NUA ($150-$20 [the basis]) and tax would be owed on that difference. The unrealized gain above that could be untaxed to inheritors, I believe.

[Alan S.]

5b is correct except it overlooks the LT loss that occurred after inheriting the shares.

Therefore, there should be LT gain of 130 emanating from lack of basis adjustment for the NUA per share and a LT loss of 50 that occurred after inheriting, with a net LT gain of 80.

The tougher part is actually reporting this on Form 8949. Seems like there should be IRS guidance on this somewhere, but I have not found it, not even for the simpler situation when the participant sells NUA shares. Perhaps it would be easier to net this out and simply report the sale proceeds of 200k with a cost basis of 120 (comprised of the 70 basis adjustment plus the 50 loss) for the net LT gain of 80, with an explanatory statement how the cost basis was derived.

[taxnerd97]

5b is correct except it overlooks the LT loss that occurred after inheriting the shares.

Therefore, there should be LT gain of 130 emanating from lack of basis adjustment for the NUA per share and a LT loss of 50 that occurred after inheriting, with a net LT gain of 80.

The tougher part is actually reporting this on Form 8949. Seems like there should be IRS guidance on this somewhere, but I have not found it, not even for the simpler situation when the participant sells NUA shares. Perhaps it would be easier to net this out and simply report the sale proceeds of 200k with a cost basis of 120 (comprised of the 70 basis adjustment plus the 50 loss) for the net LT gain of 80, with an explanatory statement how the cost basis was derived.

Thank you for your response. Yes, I am thinking the $80 LT CG for the sale is the correct answer (so we don't ever recognize the entire amount of the original $130 NUA if we sold at 200?) and maybe we can get away with an explanatory statement on the form 8949 backing it up.... Our issue right now is that all of the NUA stock is still unsold (mainly because we don't know how to value it for tax purposes) and it's all currently being reported in mom's VG brokerage acct as uncovered shares at the DOD stepped-up basis of $250/shr (so currently reporting a large unrealized capital loss) . They do give us option to file a form to update the cost basis of uncovered/inherited shares, so debating if we should just go ahead and file it, giving them the updated $120 stepped up cost basis for the stock instead (vs the original $20 pre-death cost basis) - making it easier to determine capital gain/loss when she finally sells the NUA stocks to further diversify her investments into a more conservative asset mix for her 75+ age (the NUA stock holdings value is currently 24% of her total investments...not good). We would feel better about doing this if we could just find something definitive from the IRS (or even a knowledgeable CPA or financial advisor in these matters), that directly addresses this & confirms the limited stepped up basis amount of $120 in 5b above is the proper accounting for it.

[Alan S.]

As far as I know, the IRS has never clarified how they want a sale of NUA shares reported, as there are various combinations of post LSD gains or losses possible. Seems to me the two choices are separate line items on Form 8949, one reporting the 130k NUA LTCG and another the 50k LTCL generated after the shares were inherited. The problem with that is the sale proceeds will be entered twice. The other and better option is to report as a single consolidated line showing 200k sale of inherited shares as the amount received and a cost basis of 120k. Both methods produce a net 80k LTCG with the 130k of NUA gain reduced by the 50k LTCL incurred from the reduction of value post inheritance. I'd advise just letting the broker report as uncovered shares, and keeping your own documentation of the math in the unlikely event the IRS ever inquires about your 8949.

The IRS expects that the amounts received on all the 1099B forms match the amounts you report on Form 8949 and the consolidated method would avert an IRS computer mismatch of the totals.

[taxnerd97]

As far as I know, the IRS has never clarified how they want a sale of NUA shares reported, as there are various combinations of post LSD gains or losses possible. Seems to me the two choices are separate line items on Form 8949, one reporting the 130k NUA LTCG and another the 50k LTCL generated after the shares were inherited. The problem with that is the sale proceeds will be entered twice. The other and better option is to report as a single consolidated line showing 200k sale of inherited shares as the amount received and a cost basis of 120k. Both methods produce a net 80k LTCG with the 130k of NUA gain reduced by the 50k LTCL incurred from the reduction of value post inheritance. I'd advise just letting the broker report as uncovered shares, and keeping your own documentation of the math in the unlikely event the IRS ever inquires about your 8949.

The IRS expects that the amounts received on all the 1099B forms match the amounts you report on Form 8949 and the consolidated method would avert an IRS computer mismatch of the totals.

Thank you for your input on this situation! Very helpful!