Inherited Property & Exclusions to Property held in an irrevocable TRUST at the time of death
Step-Up in Basis: How It Works for Inherited Property & Exclusions to Property held in an irrevocable TRUST at the time of death
What Is a Step-Up in Basis?
Step-up in basis refers to the adjustment in the cost basis of an inherited asset to its fair market value on the date of the decedent's death. Cost basis is what determines the taxes owed, if any, when the asset is sold. Cost basis starts with the price paid for an asset, plus any additional costs added over time to improve or maintain the original asset.
Step-up in basis, or stepped-up basis, is what happens when the price of an inherited asset on the date of the decedent's death is above its original purchase price. The tax code allows for the raising of the cost basis to the higher price, minimizing the capital gains taxes owed if the asset is sold later.
The step-up in basis provision applies to financial assets like stocks, bonds, and mutual funds as well as real estate and other tangible property.
Of course, if the price of an asset has declined from that paid by the owner's date of death, the asset's cost basis would step down instead of stepping up for heirs.
In practice, most cost basis adjustments after death are steps up, not steps down. This is because financial assets passed on to heirs are often long-term holdings, while financial assets and real estate tend to have positive long-term rates of return.
KEY TAKEAWAYS
? A step-up in basis resets the cost basis of an appreciated inherited asset for tax purposes.
? The cost basis for heirs is raised to the asset's market value on the prior owner's date of death, reducing future capital gains taxes.
? Residents of states with community property laws (These are currently the only community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington) or those with assets in community property trusts qualify for a step-up in basis on community property for the surviving spouse.
? Because the benefits of the step-up basis mostly accrue to the wealthiest households, opponents have tried to limit or eliminate the provision in recent years, without success.
Understanding Step-Up in Basis
A step-up in basis resets the cost basis of an inherited asset from its purchase (or prior inheritance) price to the asset's higher market value on the date of the owner's death.
STOCK: For example, let's suppose Alex purchases a share of stock at $10 and dies when its market price is $100. Had Alex sold the stock before dying at $50, he (or his estate after her death) would be liable for capital gains tax on a gain of $90.
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If Alex does not sell the stock during his lifetime and instead leaves the stock to his heirs, his heir's cost basis becomes $100 so that if the stock is later sold at that price no capital gains tax would be due. Capital gains tax that would have been due on the rise in the share price from $10 to $100 absent Alex's death is never collected.
REAL ESTATE: For example, let's suppose Alex purchases real estate property for $100,000.00 and dies when its market price is $1,000,000.00. Had Alex sold the real estate property before dying at $1,000,000.00, he (or his estate after her death) would be liable for capital gains tax on a gain of $900,000.00.
If Alex does not sell the real estate property during his lifetime and instead leaves the real estate property to his heirs,, his heir's cost basis becomes $1,000,000.00 so that if the real estate property is later sold at that price no capital gains tax would be due. Capital gains tax that would have been due on the rise in the share price from $100,000.00 to $1,000,000.00 absent Alex's death is never collected.
THE STEP-UP PROVISION OF REVOCABLE TRUSTS
Whether the assets are houses, money, or stocks, step up in basis at death revocable trust makes a big difference in the beneficiary’s tax obligations at the grantor’s death. If this provision is not invoked, the beneficiary’s inherited assets will amass heavy tax burdens.
ASSETS HELD IN A TRUST: Some assets held in a trust can be valued on a stepped-up basis. Only those held in a REVOCABLE or LIVING TRUST are eligible to be valued under this provision. Assets held in an IRREVOCABLE TRUST are valued at the original value, and do NOT get the Step-Up in Basis.
Law Office of Stella V. Bondar, Esq., P.C.
Real Estate Attorney