FAQ: Inheriting stocks; foreclosures revisited


Inheriting stocks; foreclosures revisited

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, Sunday June 9, 1996


Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.

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  1. Question: If I inherit stock, what is my tax basis? What if I received the stock by gift?


  2. Question: This follows your May 12th column on the taxation of foreclosures. I understand that if there is a foreclosure on a loan used to buy my residence, I may have a capital gain because the loan is "non-recourse" (the borrower is not personally liable) under California law. Do the same foreclosure and tax rules apply if I refinanced the original loan or have obtained additional loans on that property?


  1. Answer to Question #1:

    Your basis establishes your tax investment in an asset; it is used to measure your subsequent gain or loss. In most cases, your basis is the price you paid for an item. When you receive an asset by a gift or through inheritance, however, your basis is determined differently. Generally, a decedent's assets receive a "stepped-up" basis to fair market value ("FMV") at his date of death (or, in some cases, the FMV 180 days after death). This is an advantage to you since the gain inherent in those assets is eliminated. Assets received by gift, however, receive a "carry-over basis": The recipient's basis is the same as the donor's.

    For example: Suppose your grandfather bought 100 shares of IBM at $10 per share and that stock is now worth $100/share. If he gifted the stock to you, your carry-over basis is $10/share; if you sold the stock, you'd have a $90/share capital gain. If you inherited the stock valued at $100/share, that would become your basis and a later sale would use that new basis to measure your gain or loss.


  2. Answer to Question #2:

    Additional financing or refinancing could change the original answer. California's anti-deficiency rule applies only to those funds used to purchase a residence. These loans are considered non-recourse. While a non-recourse loan protects a borrower by limiting a lender's rights to recover its loan to the sale of your residence, it could have adverse tax consequences if the borrower was insolvent before the foreclosure occurred. The anti-deficiency rules do not apply to additional financing (second mortgages or home-equity loans). These loans are classified as "recourse."

    Once a loan is recourse, the tax treatment changes: That portion of the loan that exceeds the FMV of the property is treated as income from the cancellation of debt ("COD") and is taxed at ordinary income rates. COD income, however, may be excluded from gross income if the debtor is insolvent before the debt is canceled. Capital gains, however, do not qualify for this COD exclusion.

    Example: Suppose you originally bought your home for $100,000 (borrowing $80,000), and when it was worth $150,000, you borrowed another $40,000 with a home equity loan to pay other debts. If foreclosure occurs when your home has a FMV of $110,000, with a combined debt of $120,000, then you'd have a $10,000 capital gain plus $10,000 of COD income. Your capital gains is always included in your income, but may exclude the $10,000 of COD income, if you were insolvent before the foreclosure occurred.

    If you refinanced the first loan with your original lender for $80,000 to obtain a lower interest rate, the loan should retain its non-recourse character. Refinancing by a new lender, however, is not protected by the anti-deficiency laws, and the debt becomes recourse. In other circumstances, whether a loan falls within the anti-deficiency protections has been subject to varying court interpretations. I leave that issue to the real estate attorneys.

    In conclusion: Loans used to purchase a home are non-recourse and may generate capital gains or losses upon foreclosure. Additional loans, or an original purchase loan which is later refinanced by a new lender, are recourse and could produce COD income, to the extent the amount owed exceeds the FMV of the property.



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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**