What is a “Step Up in Basis”?

Sep 01, 2015

Step Up in Basis

This is probably the best and biggest tax break the IRS code allows.  Normally, when you sell an asset that has appreciated in value, you pay a capital gains tax. But, for assets that are inherited, the IRS has a special rule, called the “step up in basis.”

This is the date of death value of an inherited asset used to calculate capital gains taxes when the asset is later sold.

So, why is it so important?  Taxes.  It saves your beneficiaries lots of money that they would otherwise pay in taxes.

For example:  Ben is a beneficiary who inherited a house from his Dad when his Dad passed away in 2014. His Dad bought the house in 1997 for $400,000. At the time of Dad’s death (2014), the house was worth $1,000,000.  The step up in basis rule allows Ben to receive a “step up” in the original cost basis from $400,000 to $1,000,000. If Ben decides to sell the property in 2015 for $1,200,000, Ben will only pay a capital gains tax on what he sold it for ($1,200,000) minus his stepped up cost basis ($1,000,000).  So, Ben will pay capital gains taxes on his gains ($200,000). If there was no step up in basis, Ben would have to pay a capital gains tax on $800,000 (sales price of $1,200,000 minus the original cost basis of $400,000).

So, how does it work and how can you take advantage of this concept with your appreciating assets?

In order to take advantage of this rule, your beneficiaries must inherit your asset. For example, your beneficiary can inherit your asset through a living trust.

Further, if you are married and you hold your property in “joint tenancy” you will retain the original cost basis and will not be able to take advantage of the step up in basis rule. In order to take advantage as a married couple, the asset must be held as community property.

Married couples sometimes receive a double step up in basis. The appreciating assets receive a step in basis at the first spouse’s death and again at the second spouses death, so the ultimate beneficiary receives a double step up.

While utilizing a step-up in basis can lead to big tax savings, there are limitations to consider. For example, the rule does not apply to assets held jointly with children or to deferred accounts such as IRAs or 401(k)s. Also keep in mind that assets also can receive a “step down” in basis depending on the value.

Optimizing an estate plan to minimize inheritance, estate and capital gains taxes is no easy task.  Since everyone’s situation is unique, it is important to plan your estate with these and other considerations in mind.



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