Key Takeaways
- Inherits asset basis at fair market value on death.
- Eliminates capital gains tax on pre-death appreciation.
- Applies to most inherited capital assets like real estate.
- No step-up for retirement accounts or gifts.
What is Step-Up in Basis?
Step-up in basis is a U.S. tax provision under Internal Revenue Code Section 1014 that adjusts the cost basis of inherited property to its fair market value (FMV) as of the decedent's date of death. This adjustment eliminates capital gains taxes on the asset’s appreciation during the original owner's lifetime, benefiting heirs by reducing taxable gains when they sell inherited property.
The concept of gain is central here, as the step-up resets the asset’s basis, so you only owe tax on gains accrued after inheritance, not before.
Key Characteristics
Step-up in basis offers several distinct features that impact estate and tax planning:
- Basis Adjustment: The cost basis of inherited assets is reset to FMV at death, which can significantly reduce capital gains tax liability.
- Applicable Assets: Includes real estate, stocks, bonds, and collectibles, but excludes retirement accounts like IRAs.
- Tax Impact: Eliminates tax on pre-death appreciation, aligning with the ability-to-pay taxation principle.
- Valuation Date: Basis is generally stepped up on the date of death or an alternate valuation date if elected by the estate.
- Limitations: Only the decedent’s portion of jointly owned property typically receives the step-up.
How It Works
When you inherit property, the IRS allows you to reset the asset’s original cost basis to its fair market value at the time of the decedent’s death. This means if you sell the asset shortly after inheriting, you may owe little or no capital gains tax.
For tax reporting, you calculate your gain or loss by subtracting the stepped-up basis from the sale price. This process contrasts with gifted assets, where the basis carries over and taxes may apply to the full appreciation. Understanding this distinction is crucial for effective estate planning and tax optimization.
Examples and Use Cases
Step-up in basis applies broadly but is especially relevant in these scenarios:
- Stock Investments: If you inherit shares of companies like SPY or IVV, your basis resets to the FMV at death, potentially reducing taxes on future sales.
- Real Estate: Homes or land passed down benefit from step-up, minimizing capital gains when heirs sell the property.
- Joint Ownership: In community property states, both spouses’ shares may receive a double step-up, enhancing tax benefits.
- Collectibles and Business Interests: Art, furnishings, and some business holdings may also qualify, though special rules can apply.
Important Considerations
While step-up in basis offers significant tax advantages, it is essential to consider potential limitations and planning nuances. For example, retirement accounts do not receive a step-up and are taxed differently, so integrating multiple asset types in your estate plan matters.
Also, proposed tax reforms could shift the current step-up system to a carryover basis, increasing tax burdens on inherited gains. Consulting with a tax professional can help you navigate these complexities and implement strategies that align with your financial goals and the nuances of salvage value concepts in asset valuation.
Final Words
Step-up in basis can significantly reduce capital gains taxes on inherited assets by resetting their value at the date of death. Review your estate plan with a tax professional to ensure you’re maximizing this benefit and minimizing tax liabilities for your heirs.
Frequently Asked Questions
Step-Up in Basis is a U.S. tax rule that adjusts the cost basis of inherited property to its fair market value on the original owner's date of death, eliminating capital gains taxes on appreciation during their lifetime.
Step-Up in Basis benefits heirs by resetting the asset's value at the time of inheritance, so they only pay capital gains tax on any appreciation after they inherit it, not on gains accumulated before.
Most capital assets qualify, including real estate, stocks, bonds, mutual funds, art, collectibles, and some business interests. However, certain assets like retirement accounts do not receive a step-up.
When property is gifted, the recipient inherits the original cost basis, meaning they pay capital gains tax on the full appreciation. In contrast, inherited property gets a stepped-up basis, potentially reducing or eliminating capital gains tax.
Only the decedent's share of jointly owned property receives a step-up in basis. For example, in joint tenancy, only the deceased owner's portion is adjusted to fair market value.
Yes, exceptions include retirement accounts like IRAs, which do not get a step-up and are taxed as income when withdrawn, and assets in irrevocable trusts that may not be included in the estate for basis adjustment.
Step-Up in Basis encourages holding assets until death rather than gifting them, as it can save heirs significant capital gains taxes by resetting the asset's basis to its market value at death.
Yes, estates may elect an alternate valuation date instead of the date of death to determine the fair market value, which can affect the stepped-up basis and potential tax outcomes.
