How to Manage Your Basis “Step Up”

If you are planning to leave someone an inheritance, or someone has left you an inheritance, it is important for you to understand how to manage your basis “step up.” A “step up” in basis is the adjustment of the value of an appreciated asset – for tax purposes – upon inheritance.  It’s all about the Capital Gains Tax and transferring property in a way that affords the best outcome, –meaning the highest basis and the lowest tax due on sale.

IRS Taxes

An Executor may have to file estate tax returns based upon the size, or cumulative date of death value of the assets of the estate.  It is unusual these days for me to have an estate that needs to file an estate tax return as the value of the estate would have to exceed $5.25 million.  Nevertheless, estates with fewer than $5.25 million in assets may qualify for basis step-up, so its important to understand the potential tax consequences and plan or act accordingly.

Step Up Basis Explained

Simply put, when an asset is passed on to a beneficiary, the value of that asset at the time it is inherited is generally higher than it was when the original owner acquired the asset.  To the extent the asset is properly included in the decedent’s “taxable estate”, the asset will receive a “step-up” in basis.  Whether or not the estate exceeds the taxable thresh-hold is irrelevant to the availability of basis step up.

How an Asset is Transferred on Death Matters

If an asset passes to a beneficiary as part of a probate proceeding, the asset will get a full step-up as the asset is fully included in the taxable estate.  This means that the basis will adjust from the original purchase price to the date of death value.   If an asset is given during life to a person outright with no strings attached, there is no step up as the asset is fully excluded from the taxable estate. The net result may be a significant capital gains tax which could have been avoided.  What are some other options?  “Pay on death” or “Transfer on Death” — because decedent had total control of the asset during life, the asset is properly included in the taxable estate and entitled to a step up.  Alternatively,  although Joint Ownership or Joint Tenants with Rights of Survivorship effectively avoid probate, for tax purposes the transfer is considered partially gifted during life and partially on death.  The recipient gets a partial step up on death.

Keeping good records and obtaining paperwork from the courts, trustees, and other parties involved will help ensure you are using the step up basis correctly and minimizing the risk of IRS audits.

What is the Best way to Transfer Assets?

It depends on the totality of concerns and circumstances as well as the objectives to be met.

If you have questions about an inheritance you hope to leave or expect to receive – contact us to learn about your options.

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