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Coming Out Different

Richard Connor

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.”

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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.

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MikeinLACA
MikeinLACA
9 months ago

Interesting wrinkle in the RMD world. I’m not sure I agree that there’s much to “saving you the cost and hassle of buying the stock” by receiving the shares from an IRA. Zero-cost discount brokers and a simple online click mean there’s no cost or hassle at all to repurchasing the stock.

The comment about liquidating a 401(k) before transferring to an IRA hits home with me. As a a federal employee, there’ll come a day when I transfer my Thrift Savings Plan to a private firm. I’ll lose the (essentially) free investment funds that the TSP offers. Will just have to recreate them with Schwab / Vanguard ETFs.

Rick Connor
Rick Connor
9 months ago

I didn’t write about this, but it is also permissible to perform a Roth conversion as a in kind transfer. This has the same potential advantage, better actually, if the share price is depressed and you can transfer shares to a Roth. Any future growth is not taxed.

Humble Reader
Humble Reader
9 months ago

I did an in-service transfer from my 401(k) to an IRA account. It was a trustee-to-trustee transfer without any tax consequences. While I would have preferred an in-kind transfer to avoid market fluctuation risk, the company holding the 401(k) insisted that it could only be done by liquidating the holdings and transferring cash. The process required almost a month between the liquidation and when the funds showed up in my IRA. So I was un-invested for this period of time. The transfer was done by printing and mailing a check. I was lucky that the market was relatively flat during this time; taking a breather during an otherwise up cycle.
There seems to be a gap in the regulations about how transfers and distributions may be performed. If in-kind transfers are allowed by law then it should always be the account owner’s choice to do an in-kind or cash-out transfer. It should not ever be the trustee’s choice.

wtfwjtd
wtfwjtd
9 months ago

Yep. It has to be cash going in, but it can be securities or other assets coming out. This is one way that those with RMD’s aren’t forced to liquidate in a bad market, and most brokerage firms are happy to accommodate this. All you need is a companion taxable account at your brokerage. It kinda makes you root for a down market at RMD time, so long as you don’t need the proceeds for income.

OldITGuy
OldITGuy
9 months ago

Thanks! Interesting article on something I wasn’t aware of. I can think of one use for this. I have an elderly in-law who’s still investing her RMD’s with her investment advisor. They’re loaded funds (yeah, I know but he’s her “friend and trusted advisor”). In kind distributions would eliminate the 2nd second load if she’s paying a load on the reinvesting. I’ve asked in the past if she’s paying a load again on the reinvestments, but my inquiry wasn’t really appreciated so I quickly backed off. Unfortunately “money” isn’t a topic every family openly discusses (often to their detriment).

Mark Schwartz
Mark Schwartz
9 months ago

Does the in kind stock distribution become a tax free asset going forward if the asset remains as a stock distribution? If I understand the rule the taxes are paid on the RMD as the value is calculated on that specific distribution day and taxes are paid the same as if the shares were sold as cash. If not then the eventual sale of those shares would be taxed on the sale which would be double taxation…which I think we fought a war over..

Rick Connor
Rick Connor
9 months ago
Reply to  Mark Schwartz

Mark, you are correct that the distribution is considered income for that years taxes. The transferred stocks are just as if you had bought them the day of the distribution. The period starts on the day of distribution and the cost basis is the value on the day of distribution. Any future sale would be a short or long term gain (or loss) based on the cost basis. So you are only taxed on the gain in the future. If Capital Gains rate stay low then this could be a good strategy if you have the cash to pay the initial taxes, and don’t need the money right away.

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