(also applies to timber, personal property, and some types of liquid accounts)
Stepped-up basis refers to a tax policy that looks at the market value of assets
at the time a person inherits them instead of the value when the prior owner
purchased the assets.
The rules for stepped-up basis:
A stepped-up basis is a tax law
that applies to estate transfers. When someone inherits investment assets, the IRS
resets the asset's original cost basis to its value at the date of the
inheritance. The heir then pays capital gains taxes on that basis.
The tax code of the United States
holds that when a person (the beneficiary) receives an asset from a giver (the
benefactor) after the benefactor dies, the asset receives a stepped-up basis,
which is its market value at the time the benefactor dies (Internal
Revenue Code § 1014(a)).
The Internal Revenue Code (IRC) §
1014(a) states
that when a beneficiary receives an asset from a benefactor after the
benefactor dies, the asset receives a stepped-up basis. The stepped-up
basis is the market value of the asset at the time the benefactor dies. The
purpose of section 1014 is to provide a basis for property acquired from a
decedent that is equal to the value placed upon such property for purposes of
the federal estate tax.
A step-up in basis can significantly reduce your
capital gains tax. For example, if a $100,000 property increases in value
to $200,000, a step-up applies to 50% of the appreciation, resetting its cost
basis to $150,000. Not all inherited assets are eligible for a step-up
basis. Assets such as retirement accounts, including IRAs and 401(k)s, do
not receive this step-up
President Joe Biden proposed
raising taxes for long-term gains over $1 million. This means that high-income
investors over that amount would be taxed as ordinary income and pay a top rate
of 39.6% or whatever you tax rate actually is...
PROCEEDS - minus ORIGINAL COST BASIS =
PROFIT
Long-Term Capital Gains Rate x Profit = Capital Gains Tax Owed
15% capital gains rate x $ in profit = $ in capital gains taxes
This is significantly more preferable than if your capital gains are short-term in nature.
Step-Up Basis in Community Property States Is Even Better
Residents of nine different community
property states have the ability to take advantage of a double step-up basis
tax rule. This allows a step-up basis on all community property for the
surviving spouse. Community property means any asset that was accumulated
during the marriage with the exception of any gift or inheritance.
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are the nine states. In community property states, all assets and debts acquired during the marriage are considered joint property and are divided equally between spouses in the event of a divorce.
In many other states, neither assets
that are only owned by the surviving spouse or jointly owned assets do not get
the same treatment. The assets of a surviving spouse don’t get any step-up
basis and jointly owned assets only get half of the basis. However, a surviving
spouse can obtain the step-up basis on anything that is inherited from the
deceased in any state.
A stepped-up basis is a tax law that applies to estate
transfers. When someone inherits investment assets, the IRS resets the asset’s
original cost basis to its value at the date o the inheritance. The heir then
pays capital gains taxes on that basis. The result is a loophole in tax law
that reduces or even eliminates capital gains tax on the sale of inherited
assets.
Let's assume you are wealthy and you own a ten million dollar house in Emerald Bay, Laguna Beach. You never want to sell the house, you want to give it to your children when you die because no taxes are due on the gain because you inherited the house that Dad bought for $450,000.00 The basis was $450000. when you inherited it was worth three million and now your children also pass on the gain and rent that house forever. Unrealized capital gains (air money because you never sell the real estate) are not taxed as income because the owners never cashed in and sold.
A basic rule for income tax purposes is:
the basis of an asset received from a decedent is the lesser of the asset's fair market value on the decedent's date of death
or the decedent's basis in the asset on the date of death.
In most circumstances the basis will be the lesser of the two. The executor can allocate a maximum of $1.3 million in stepped-up basis to estate assets transferred to any beneficiary.
Under the current fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value.
There is a principal that it is always best to recover basis as fast as possible from an event (death). Heirs can decide to allocate sufficient basis to cover the gains, sell some things and keep others.
GIFTS VS Waiting for the step up at death
If your grandmother decides to make a gift of stock during her lifetime (rather than passing it on when she dies), the “step-up” in basis (from $500. original purchase cost to $1 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift. If grandmother gives it while she is alive two different taxes might be owed. If she waits for her death no tax is due.
Tell granny to leave it in her will if it is real estate.
This is not legal advice. And yes the Emerald Bay example is real.
