When you’re creating an estate plan or inheriting certain assets from a family member, the step-up in basis rule will likely apply to most of the assets. Of the 40% of American adults who have created a will, many overlook what the step-up in basis means for inherited assets. Understanding how this guideline works can make it easier to calculate how much taxes will need to be paid on an inheritance.
How Does Step-up in Basis Work?
Step-up in basis is the alteration to the cost basis of an asset to the fair market value it has on the day that the decedent passes away. Cost basis allows you as a beneficiary to identify how much money in taxes will be owed once you sell the asset. When using cost basis to determine the value of an asset, it starts with the price that was originally paid alongside any extra costs that were added to maintain or improve the asset over time.
When an asset is inherited, the step-up in basis is the process that occurs when the asset’s price is higher than the original purchase price on the day the decedent passes away. The Internal Revenue Code provides beneficiaries with the ability to increase the cost basis of the asset to the higher value, which reduces the amount of capital gains taxes that they owe when they sell the asset.
In the event that the asset’s value at the time of the decedent’s death had dropped from the original price, the cost basis would instead in effect “step down” for beneficiaries. If you are about to receive inherited property or are currently drafting a will, our New Jersey estate planning lawyers could answer any question you have about step-up in basis and what it means for your assets.
As an example of the step-up in basis, let’s say that someone buys a single share of stock at $5 but passes away when the market value reaches $20. If they had sold the stock at the $20 price before passing away, they would be tasked with paying capital gains tax on the gain of $15.
If, however, they pass away before selling the asset, the heir’s cost basis will increase to $20, which means that capital gains taxes wouldn’t be due if the heir sells the asset at the same price. While some people view the step-up in basis as a tax loophole, it’s still legally allowed by the IRS.
Benefits of Providing Assets in a Will
There are several reasons why people choose to provide beneficiaries with assets in their will, the primary of which is that doing so allows loved ones to obtain an inheritance that isn’t subject to high capital gains taxes. If the assets and property were transferred to loved ones while the individual was still alive, the recipient would owe capital gains taxes.
Assets that are gifted or transferred before death come with a cost basis that matches the purchaser’s original cost. The capital gains tax will then be calculated based on the difference between the initial cost basis and the eventual sale price.
Which Assets Do the Step-up in Basis Rule Apply To?
The step-up in basis rule applies to many different types of assets, which include everything from stocks and bonds to brokerage accounts and personal property. Art and real estate also qualify for the step-up in basis guidelines.
Keep in mind that not all assets are able to qualify for the step-up in basis. For instance, the surviving spouse is unable to take advantage of an additional step-up in basis for any assets that were put into an irrevocable trust at any time before their spouse’s death. The numerous types of assets that the step-up in basis rule doesn’t apply to include everything from IRAs and 401(k) accounts to pensions and tax-deferred annuities.
If you’re currently creating an estate plan and need some guidance, call our New Jersey estate planning lawyers today at (201) 996-1200 to learn more about the different estate planning strategies available to you.