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Right now, major tax legislation is being considered by Congress, but the good news is that step up in basis does not appear to be on the chopping block.
Step up in basis is the readjustment of the value of an appreciated asset for tax purposes that is inherited. This readjustment of basis (referred to as step up in basis) is tied to the capital gains taxes.
A step up in basis can save thousands of dollars in taxes when the inherited asset is sold.
Capital Gains Tax Rules
In order to understand this benefit, we need to start with the capital gains tax rules. When you own an asset and sell it for a profit, there is a capital gain that is taxed. The gain is calculated by taking the selling price and subtracting the basis.
The Federal Tax rate for long-term capital gains ranges from 0%, 15%, or 20% based on taxable income. However, which one of those long-term capital gains rates applies to you depends on your taxable income. The higher your income, the higher the rate. The gain may also be subject to state income taxes.
For example, you purchase a stock for $10,000 and then sell it for $20,000. The gain would be $10,000 and if you are in the 20% federal tax bracket the tax would be $2,000.
Another example, you own real property that you purchased for $250,000 and sell it for $500,000. The gain would be $250,000 and if you are in the 20% federal tax bracket the tax would be $50,000.
Basis can be complicated as there are different types: cost basis, adjusted basis, carryover basis and step up in basis (and even step down in basis).
Step Up in Basis
Now, let’s look at a sale of an appreciated asset that is inherited. The first step is to adjust the basis to the fair market value as of the date of death.
For example, an appreciated asset worth $750,000 was purchased for $250,000 (cost basis).
If the asset is then inherited, the basis would be adjusted to the fair market value at the date of death ($750,000). If the asset is sold for $750,000, there would be no capital gain, hence eliminating the capital gains tax.
The Benefit of Step Up in Basis
This can be an important planning point. Individuals with non-taxable estates who make lifetime gifts of appreciated assets are missing the opportunity for beneficiaries of their estate to receive a step up in basis, thus minimizing or eliminating capital gains taxes. The basis of a gifted asset is a carryover basis (the same as the donor’s basis) and there is no step up in basis.
Asset Gifted During Lifetime Asset Inherited and then Sold
Selling Price $750,000 $750,000
Basis $250,000 $750,000
Gain $500,000 $0
Capital Gains Tax $100,000 $0
(Assuming 20% federal tax bracket, a long-term capital gain and fair market value at death was $750,000)
It is important that you do this correctly or else you could be overpaying, or worse, underpaying your taxes which can make you subject to penalties and interest.
It is best to seek the advice of a tax professional who can make the basis calculation for you so that you can report the sale of the asset correctly. Taking advantage of the step up in basis rules can save thousands of dollars. Here at the Russo Law Group, we understand the complexities of tax rules and regulations. Contact one of our experienced tax attorneys today.