When it comes to inheriting assets, one crucial concept that can significantly impact your financial situation is the step-up in basis. This term refers to the adjustment in the tax cost basis of inherited assets to their fair market value at the time of the original owner’s death. Understanding step-up basis is essential for heirs and beneficiaries as it can have profound implications for capital gains taxes. In this article, we will explore the concept of step-up in basis upon inheritance and its implications.
What is Step-Up in Basis?:
In simple terms, the basis of an asset is the value from which capital gains taxes are calculated when you sell the asset. In some situations, when you inherit an asset, the IRS provides a favorable tax treatment known as the step-up in basis. This means that the value of the inherited asset for tax purposes is adjusted to its fair market value on the date of the original owner’s death.
For example, if you inherit a family home that was purchased for $100,000 (the original owner’s tax cost basis) but is now worth $500,000 at the time of the owner’s death, your new tax basis for the property is $500,000. This adjustment effectively erases any potential capital gains tax liability on the appreciation in the property’s value that occurred during the original owner’s lifetime (if the property were sold immediately after inheriting it).
Implications for Capital Gains Tax:
The step-up in basis can have significant income tax benefits for heirs. When you eventually sell the inherited asset, you will only owe capital gains tax on any increase in value that occurs after the date of inheritance. In our previous example, if you sell the inherited home for $550,000, you will only owe capital gains tax on the $50,000 increase in value since the date of the inheritance, rather than the $450,000 increase in value from the original purchase price by the original owner.
Some Exceptions and Limitations:
While the step-up in basis is generally a favorable tax treatment for heirs, there are some exceptions and limitations to consider:
- Jointly Owned Property: if you inherit property that was jointly owned with the deceased, only the portion owned by the decedent receives the step-up in basis (unless the asset is considered a community property asset).
- Inherited IRAs and Retirement Accounts: Inherited traditional IRAs and retirement accounts do not receive a step-up in basis. Withdrawals from these accounts are typically subject to income tax (income in respect of decedent).
- Special Use Valuation: In some cases, certain farms or closely held businesses may qualify for a special use valuation, which can affect the step-up basis calculation.
Understanding the step-up in basis upon inheritance is essential for anyone who may inherit assets. This favorable tax treatment can significantly reduce capital gains tax liabilities and provide financial advantages for heirs. However, it is crucial to consult with legal and tax experts to navigate the complexities of the various taxes and ensure you make the most of the step-up in basis.
If you, a friend or family member need help restating or establishing an estate plan or administering a trust after a death, please reach out to our Intake Department at 760-448-2220 or at https://www.geigerlawoffice.com/contact.cfm. We have offices in San Diego and Orange Counties, but we assist families throughout California as well.