Author: Chris Denham, CPA, J.D.
The basis step up on inherited assets is currently one of the biggest tax breaks available to you to transfer your assets to your heirs. So you might be asking, “What is a basis step up and how can it save taxes?”
When an asset, such a stocks or real estate, is sold you pay taxes on the gain from the sale. The gain is calculated by taking the sales price less the amount of basis in the property. Generally, your basis is the amount you paid to purchase the asset. If that asset has been held for many years and has experienced appreciation the gain can be significant. Selling appreciated assets now it can result in a big tax bill leaving fewer assets to pass on to your family or friends.
The basis step up can help to avoid those taxes. Here’s how it works. When a person passes away the basis of the assets owned at death is reset to the fair market value of the asset at the time of death. The step up is not limited to a single asset or group of assets. It applies to all assets owned when you pass away. If your estate or your heirs sell the inherited assets with a stepped up basis the result would be no gain and no tax due on the sale.
Let’s look at an example. In our example John purchased a vacation home in 1990 for $100,000. That home is now worth $500,000. If he sold it now his gain would be $400,000 and he would pay capital gains tax on that amount. If John died today and left the vacation home to his daughter Joan her basis in the vacation home would be $500,000. She could choose to sell the home now and have no gain or tax on the transaction or continue to hold the property. When she eventually chooses to sell the resulting gain would be based on her stepped up basis.
Investments work the same way. The stocks or other investments you transfer to your heirs at death also will be stepped up the fair market value allowing your heirs the option to sell the investments without any tax due or continue to hold the investments with a higher tax basis.
In order to maximize the benefit from this tool you should start planning now. Start by identifying any assets you own that would be good candidates for transferring at death in order to maximize this tool. You should look for any assets that have experienced significant appreciation in the time you have owned them. Have you owned your home for decades or maybe a vacation property that you want to pass to your family? Maybe you purchased some successful tech stock in the early 2000s. These would all likely be good assets to consider passing on to your heirs with stepped up basis rather than selling them and paying the tax, leaving less for your heirs.
As part of the planning process you may want to review how your property is titled or owned. If property is owned jointly the step up will only apply to the decedent’s half of the property unless you live in a community property state. If the inherited property was owned entirely by the individual that passed, the basis step up will apply to the entire value of the property. Strategically titling your assets to utilize the basis step up can maximize this tax saving opportunity.
What if you want to make gifts to your children or other family members now? If you don’t want to wait until your passing to make gifts to your family or friends you should consider making gifts of assets that haven’t seen significant appreciation. The easiest is cash but you should also consider securities that were recently purchased or investments that haven’t performed like you’d hoped. These can be used or sold without big tax impacts to your family or friends.
By holding appreciated assets until your death, the tax savings can be considerable. A little planning now can significantly increase the value of the inheritance and legacy you leave behind.
To learn more about this topic contact Origin CPA Group today.