An inheritance can be comprised of cash, securities, real estate, or other assets. When you inherit securities like stocks, there are income tax and strategic considerations. Here are some that you should keep in mind.
How are stocks taxed when you inherit them?
When a spouse or common law partner is a beneficiary, assets can be transferred to them on a tax deferred basis. So, for this section, we will assume a non-spouse beneficiary.
For non-spouse beneficiaries, inheriting stocks usually triggers tax consequences at the estate level, not for the individual. The estate settles any taxes owed before distributing the after-tax proceeds to the heirs.
A registered account like a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) is fully taxable based on the account value. The market value of the account on the date of death is considered income to the deceased. The tax is payable on their final tax return. Income or growth after that is taxable to the beneficiary:
- If the estate is named as beneficiary, it will pay the incremental tax.
- If an individual beneficiary is named, they will pay the tax on the post-death income or growth accrual.
A tax-free savings account (TFSA) is tax-free at death, but likewise, income or growth after that is taxable to the beneficiary (estate or individual).
A non-registered account is subject to capital gains tax on death, with the market value minus the adjusted cost base of each stock resulting in a capital gain (or loss, if trading at a lower value). Once again, subsequent income is taxable.
Since a non-registered account cannot have a beneficiary, the resulting tax is borne by the estate. If a stock is sold for a capital gain, post-death growth is also taxable. But if a stock is transferred to a beneficiary as part of their inheritance without selling it, that does not trigger tax on the post-death growth. Instead, the recipient’s cost base for their future capital gains purposes would be the market value at the time of the death.
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Do you have to sell stocks you inherit?
Stocks are often sold to pay tax and estate costs, with the net cash proceeds transferred to the beneficiaries. An executor may sell all of the estate assets regardless to reduce the risk of the market values declining to prevent being responsible for the estate losing money.
However, the executor of the estate can choose to transfer assets in kind—or as is—to a beneficiary. This can include stocks that were owned previously by the deceased.
As a result, a beneficiary can end up with a stock inheritance.
What to do with an inheritance of stocks
The question then becomes whether to keep stocks if you can sell and transfer cash, or to transfer stocks in kind.
From my perspective, inheriting an asset is unintentional. It is one thing to buy Canadian Pacific Railway shares on purpose but keeping them just because someone else bought them is questionable.
It is like inheriting someone’s clothes. If they fit and they are nice, maybe you will keep them. But if they are the wrong size and out-of-date, why wear them? Stocks need to be the right fit for your portfolio, and you should be careful about keeping them simply because you inherit them.
Should you keep the investments at the same financial institution?
Some beneficiaries like to maintain continuity. This can include keeping the same investments in the same place. In some cases, with an investment advisor, and in other cases, in a self-directed account.
An advisor is obviously motivated to encourage the beneficiary to keep the account with them. If there is an existing relationship, this can be a good reason to maintain continuity—but if there is not, an investor should not just keep the account as is just because. They should decide consciously to maintain the relationship and interview the advisor just like they would if they were selecting a brand-new one.
And if the account is a self-directed account and the beneficiary has little to no investing experience, they should be careful about trying to step into the shoes of the deceased. Not everyone is meant to be a do-it-yourself investor. You are not obligated to make the same financial decisions as someone who left you a stock inheritance.
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Tax implications of selling stocks after you inherit them
When you receive an inheritance of stocks, the market value upon the death of the deceased was already taxed. If the stocks were held in an RRSP, RRIF, or TFSA, the appreciation in the stocks until the time of transfer would also be taxed to the estate or beneficiary.
If stocks were transferred in kind to a beneficiary from one of these tax sheltered accounts, it would be the higher of the value at death or the value at transfer that would become the adjusted cost base for the recipient and determine capital gains or losses in a non-registered account—because tax would have already been paid up to that value.
In the case of a non-registered account, an in-kind transfer works differently. The market value at the time of death is taxed, but as mentioned previously, the stocks can be transferred to a beneficiary on a tax deferred basis. So, the market value at the time of death is the adjusted cost base for capital gain and loss calculations in a non-registered account.
Final thoughts
Think twice about keeping stocks just because someone left them to you as an inheritance. Since there is generally little to no tax advantage, it is often easier to receive an inheritance in cash. You can then start fresh by building a new investment portfolio or adding to your existing investments—or considering options like paying down debt or spending some of the inheritance.
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