What Is a Step-Up Basis?

When developing a comprehensive estate plan, it is important that you consider current tax laws. This will allow you to choose a strategy that will minimize your tax liabilities while also achieving your estate planning goals. One of the most important tax liabilities to consider is the potential of capital gains tax. Many successful estate planning strategies will minimize capital gains tax liabilities by taking advantage of what is known as a “step-up in basis.”

What is step-up in basis?
The readjustment of the valuation of an asset that has increased in value, for tax purposes of an inheritance, is referred to as a step-up in basis. This changes the valuation of the asset when the asset transfers ownership to an heir. When calculating capital gains taxes, a step-up in basis will take the value of the asset upon inheritance rather than when your heir eventually sells the asset in the future.

How does step-up in basis work?
There are many types of assets that step-up in basis can apply to, one of the most common being real estate. Assume that you purchased a home for $250,000 which has continuously appreciated over the years. If the property is valued at $500,000 when you pass away, that amount will be the cost basis used to determine the capital gains tax charged when your heir eventually decides to sell the property.

Therefore, if your heir sells the home for $600,000, he will only be liable for $100,000 worth of capital gains for tax purposes. This means the first $250,000 in appreciation is exempt from
capital gains tax liability.

Community property states
Those who live in a community property state can take advantage of the step-up in basis rule twice. This happens when you and your spouse own an asset, such as a home. If your spouse passes away, full ownership of the home transfers to you. If you were not in a community property state, only half of the co-owned home would receive a step-up in basis. Alternatively, in a community property state, you would receive a step-up in basis of the entire home.

Then, when you eventually pass away, your heir will also receive another step-up in basis when he or she inherits the home. Essentially, your heir will benefit from a step-up in basis twice.

Planning to take advantage of step-up in basis
As you can see, it is highly important to take into account the step-up in basis rules when
developing a comprehensive estate plan. You should also keep up with any changes to the rule that might affect your tax mitigation strategy. Working with a professional financial advisor can help you keep up-to-date. Failure to take into account step-up in basis rules can result in your intended beneficiaries having to pay more capital gains taxes in the future than they otherwise would have had to.

Any opinions are those of the author and not necessarily Raymond James. Any information provided is for informational purposes only and does not constitute a recommendation.