How to treat transfer of stock or liquidated value 2 years after DOD for capital gains?

[zahngirl]

I am executor and must distribute mutual fund between 15 heirs. Some want to take the fund and retain their portion. others want to take the distributed proceeds. Am I correct that heir that takes stock, when eventually sells, will have to pay capital gains back to the date of death, whereas heirs that take the liquidated sum will have to pay capital gains for the tax year in which the cash was taken? 

[zahngirl]

Thank you.  However, I need to clarify the question with additional facts.  In this case, two years have passed, and the mutual fund has increased in value by $90,000.  Therefore, it is my understanding that an heir that takes the cash now will pay capital gains back to the date of death stepped up basis, and the heir that takes in-kind will escape tax liability, but when s/he sells his/her 1/15th portion, s/he will be liable for the capital gains, not from the date of the transfer, but from the valuation  back to the date of death stepped-up basis.  Am I correct?  Also, I am aware that we can establish the valuation at 6 months post death, which would remove $30,000 of the gain.  If you have IRC numbers for these issues, that would be most helpful.  Thank you and Happy New Year to the Turbo Tax community!!!

[bobweissman]

My understanding agrees with yours, with one added step. If the estate sells shares in order to distribute cash, the estate realizes a capital gain and is liable for the income tax on that capital gain. As executor, you have the choice to have the estate pay the tax on that income or to pass the income on to the heirs who want cash via schedules K-1 generated with the estate's form 1041.

I don't have IRC references off the top of my head, sorry. I think my head would explode if I tried to store those in there.

[bobweissman · Accepted solution]

Inheritance is generally not taxable on the recipient's federal income tax return. (Some states have inheritance tax; it is each heir's responsibility to calculate and pay that tax.)

A recipient who takes cash pays no tax. A recipient who takes shares of a security pays tax on the capital gain when he sells the shares, equal to sale price minus fair market value on date of death.