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What is Step-Up in Basis?

Learn about Step-Up in Basis and how the tax law can come into play in your estate or the estate of a family member.

When it comes to estate planning and Inheritance, there are many terms you will want to familiarize yourself with. Keeping all of the lingo straight can seem a little tricky at times. But, by knowing more about estate planning laws and legal terms, you can be better prepared for whatever might come up in the future. Let’s take a look at one question you might ask yourself when going over assets and planning for the future of an estate: What is Step-Up in Basis? Keep reading to learn more about this law and what it might mean for you and your estate.

What is Step-Up in Basis? 

Step-Up in Basis is a tax law that has to do with the transfer of an estate. It often comes into play when an estate is transferred from one person to another via an inheritance. When an asset in an estate is transferred from its original owner to the person who inherits it, Step-Up in Basis happens when that asset’s value is re-adjusted for tax purposes

How does it work?

Anything a person owns is part of their estate. When they make a Will and take care of other types of estate planning, these things they own – also known as assets – are accounted for and designated to be passed on to an heir or heirs. 

There are many assets someone can own that have the potential to go up in value over time. When a person dies, especially at an advanced age, something that they purchased several decades ago may well have appreciated in value since the time of purchase. A Step-Up in Basis mirrors this change in an asset’s value. 

For example, let’s say someone purchased stock in a soft drink company thirty years ago when it was roughly $2 a share. At the time of the stock owner’s death, the stock is now worth roughly $50 a share. Since they left their shares of this stock to their son in the Will, the son is now the owner of the stock – and responsible for any Capital Gains tax that may be owed on it. Since the stock has gone up in value – it can undergo a Step-Up in Basis. The Capital Gains tax (the tax owed from the profitable sale of certain assets that have been held for longer than one year) in the future by the new owner will be owed at the stock’s current value, not the price at which it was originally purchased. If the son keeps the stock for two years, and during that time the price rises to $60 per share, he will owe Capital Gains tax on the profit made from the $50 point at which he inherited the stock, as opposed to the entire profit made from a stock climbing from $2 to $60 a share. 

Or for another possible scenario that families may face, let’s say a couple purchased a condo for $75,000 twenty years ago. After they have both died, their two children inherit the condo – that is now worth $150,000. After holding onto it for a few years, they decide to sell the condo. Taxes owed on the sale of the condo will be owed on the difference between the condo’s sale price and its Stepped-Up in Basis price of $150,000, not its original purchase price of $75,000. If they sell the condo for $170,00, Capital Gains Tax will be owed on the $20,000 difference between the condo’s sale price and Stepped-Up in Basis value. If there was not a Step-Up in Basis law, they would have to pay taxes on the $95,000 difference between the condo’s sale price and original purchase price – a big difference!

Since taxes are owed on the profit of the condo’s sale – the amount between its current value and its sale price, and potential stock profits above the value when inherited – not the value when originally purchased – the amount of Capital Gains taxes owed on these sorts of profits will likely be lower than they would be if the value of the assets had not been adjusted.

What assets do & do not get a step-up in basis? 

Wait a minute—you might be thinking – just about everything has gone up in price over the past few decades. Is every inherited asset able to be Stepped-Up in Basis? Well, some are and some are not. Some of the assets that Step-Up in Basis can apply to are: 

  • Real Estate

  • Stocks

  • Bonds

  • Mutual Funds

  • Businesses

Assets have the potential to increase or decrease in value, and their value doesn’t always increase. But assuming the value of these types of assets has increased since their original owner acquired them, Step-Up in Basis would apply for those inheriting them. 

Some types of assets that Step-Up in basis cannot be applied to include: 

  • 401K accounts

  • Pensions

  • IRAs

  • Money Market Accounts

  • Tax-deferred Annuities

These sorts of assets certainly should be accounted for in an Estate Plan, and there are specific estate planning strategies to distribute them to heirs, but the Step-Up in Basis law will not apply to them. 

Who benefits from Step-Up in Basis? 

The Step-Up in Basis law is seen by some as a tax loophole. The beneficiary of the Will or Trust – the person who inherits the asset – is the one who most often benefits from the Step-Up in Basis law. It is very possible that the asset or assets a beneficiary inherits is worth more now than it was when it was originally purchased. If the asset is sold, its increase in value means an increase in profits. By adjusting its value to reflect its worth at the time of inheritance, the profits made on paper are reduced and likewise, so are taxes owed on the sale. 

How is Step-Up in Basis calculated? 

Step-Up in Basis applies to assets that are inherited upon a death. In order to calculate the Step-Up in Basis, the fair market value of the asset as it stands on the date of its owner’s death is noted. The worth of the piece of real estate, stock, business, or another qualifying asset is adjusted to the amount that it is valued at, at that time. 

Estate Planning Strategies

Have you made plans for your estate? Do you know what will happen to your assets and when your heirs will receive them? Will taxes be an issue – and will Step-Up in Basis help alleviate taxes on inheritance? These are all very important questions to consider. 

If you haven’t looked into creating a Will, Trust, and other important estate planning measures – don’t wait. It’s always better to be prepared, and here at Trust & Will, we seek to make the process straightforward and stress-free. You can create a fully customizable, state-specific Estate Plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning options. Get started today!

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