What Is It?
A beneficiary who inherits an asset from an estate must take into account how the inheritance impacts their own estate from an income/capital gains tax perspective. Fortunately, the United States currently permits what is known as a “step-up in basis,” which helps alleviate potential income tax burdens on a beneficiary.
How Does It Work?
When an asset is transferred upon death, the step-up in basis kicks in and adjusts the value of the asset from when it was originally acquired to its current value. The value is “stepped-up” to the asset’s value at the time the decedent died. Essentially, a step-up in basis functions as a reset for the value of the inherited asset to its current value at the date of death.
How Do You Benefit From A Step-up In Basis?
This is good news for estate beneficiaries, because with a step-up in basis, taxes are assessed on the appreciation in value of the asset from the date of their loved one’s death instead of when the asset was first acquired. Additionally, the tax is only assessed if and when a beneficiary decides to do something with the inherited asset (i.e., a sale). This protects the asset’s value, helps keep property and other assets, such as businesses, within families, and allows for unhindered transfers of wealth. Most times, if a beneficiary inherits an asset and sells it right away, they will owe no capital gains tax.
Are All Assets Eligible For A Step-up In Basis?
A step-up in basis applies to all types of inheritances, including stocks, real property, and small businesses.
I Still Don't Get It!
Here is an example that illustrates the savings gained by the step-up in basis:
Tom buys a home in 1980 that is worth $100,000. He dies in 2020 and now the home is worth $500, 000.
Tom leaves the home to Betty, his daughter. Betty wants to sell the home for $500,000 as soon as she gets appointed as Executrix of Tom's estate. With a step-up in basis, Betty will owe no capital gains because the step-up in basis allows for the home value to be “stepped-up” to the current value of $500,000 - its value at Tom's death. Because the home did not increase in value from the time Tom died to when Betty sold it, she pays $0 in capital gains tax.
If there were no step-up in basis, and assuming there were no homestead or other exemptions, Betty would owe capital gains tax on $400,000 – the increase in value from the time her father acquired the home to when Betty sold it.