Stepped Up Basis – What is it and Why it’s Important
The stepped-up basis applies to assets inherited at someone’s death. The IRS resets the asset’s original cost basis to its value at the decedent’s date of death. If the asset is later sold, the heir pays capital gains on the gain (if any) on the sale proceeds less the stepped-up basis. So, if sold immediately after inheritance, inherited assets generally have little or no capital gains.
Examples of Assets That Are Eligible for Basis Step-up:
- Stocks, bonds, mutual funds
- Real estate, including personal residence(s)
- Collectible
- Personal property
- Businesses
For assets gifted during someone’s lifetime, the donee (gift recipient) inherits the donor’s basis, known as carryover basis. The tax outcome between someone gifting during their life and at death can be dramatically different.
This tax provision allows many families to avoid capital gains tax on assets passed down through multiple generations.
Examples
John, age 90, owns a 500-acre family farm, which he now wants to gift to his son John Jr. John inherited the farm from his mother when she died in 1972. The value was $200 per acre or a total of $100,000 – so his tax basis is $100,000. The area around the property has developed, and the farm is now worth $5000 per acre or $2,500,000. If John gifts the property now, his son inherits John’s basis of $100,000. But if John passes the farm to John Jr. at his death, the basis is $2,500,000 or the current market value. Even if there is no plan to sell the farm, it is better to have the increased basis.
Let’s say John owns an apartment building instead of a farm. He paid $100,000 and has owned it for 40 years. It’s now fully depreciated and worth $1,500,000. If he passes to John Jr. at his death, the basis is reset to $1,500,000, and John Jr. can now begin depreciating it using the new value.
Spouses of decedents also receive a stepped-up basis on assets passed to them at death.
What’s a situation where the step-up is not favorable? Let’s say you purchased a tract of land, and for some reason, its value declined. At your death, it’s reset to a value lower than your cost basis. It may be advisable to sell and take the capital loss or try to match up with a capital gain.
There may be instances where it’s preferable to make lifetime gifts of assets, but you need to look at your estate planning and assets as a whole before gifting.
With stocks or bonds traded on an established market, it is relatively easy to determine the fair market value on any given day.
Other harder-to-value assets may require an appraisal to establish the stepped-up basis.
Don’t hesitate to get in touch with your Dent Moses advisor to discuss.