I LEARNED SOMETHING new while preparing a tax return recently for a widowed senior citizen. I volunteer for AARP Foundation’s TaxAide program. A widow in her mid-70s had received her 2021 required minimum distribution (RMD) from her IRA—and it consisted entirely of Exxon Mobil stock.
Her account’s custodian, instead of selling the stock and distributing cash, gave her the actual shares. This had never happened to her before, and she hadn’t requested it. Why did the custodian do it? She called to get an explanation and a rep claimed it was the “company’s decision.” Whatever that means.
Needing the cash, she directed the custodian to immediately sell the stock and send her the proceeds. The client was financially sophisticated and said she usually did her own tax returns. But the change confused her, which is why she came to AARP for help.
The three other seasoned tax preparers working that day had never heard of this kind of RMD before. I had heard it was possible to receive stock in lieu of cash, but had never seen it happen. A quick Google search cleared up the confusion and allowed us to prepare her tax return.
Receiving stock instead of cash is known as an in-kind distribution, and it happens occasionally with, say, trusts, when disbursing an estate, with employer stock in a 401(k), and—as our TaxAide client discovered—with IRAs. The federal tax code doesn’t include any specific rules about making in-kind distributions from an IRA. But the IRS instructions for generating a 1099-R form—which is issued when there’s an IRA distribution—provide the following guidance when filling out the form: “If you distribute employer securities or other property, include in box 1 the FMV [fair market value] of the securities or other property on the date of distribution.”
The IRS won’t know if the distribution was in cash or securities. All it cares about is that those age 72 and older take a distribution from their retirement accounts that meets the required minimum amount.
Why would a retiree want an in-kind distribution from an IRA instead of a cash distribution? There’s no immediate tax benefit. But suppose you own a stock whose value is currently depressed and you’re confident it’ll bounce back. Conceivably, you might choose an in-kind distribution. That’ll move the shares into your regular taxable account, thereby saving you the cost and hassle of buying the stock. You might also opt for an in-kind distribution if, say, you own shares of a mutual fund that’s closed to new investors or for which you paid a sales commission.
If you opt for an in-kind distribution, it’s tough to know the precise value of the securities when the distribution is actually processed. If you want to receive a specific dollar amount, one strategy is to request slightly less than the RMD. You can then check the value of the RMD when you receive it. If it’s less than you’re required to take, you can request a cash distribution for the difference, thus ensuring you don’t get hit with tax penalties.
When you receive an in-kind distribution of securities in your taxable account, your cost basis is the value when the shares were distributed from the IRA, and the holding period starts anew on that date. If you then sell any of the shares in the first year, any gain since the distribution date will be taxed as a short-term gain. If you wait more than a year to sell, the lower long-term capital gains rate would apply.
Our client had the custodian sell the shares as soon as she could. She ended up with a $60 short-term capital gain. On her tax return, she reported the IRA distribution, as shown on the 1099-R form, plus the short-term gain based on the subsequent sale of the Exxon stock.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.