Step-Up in Basis at Death
A number of topics may motivate someone to consider estate planning. A change in family circumstances, a reminder of mortality, a new life, management of tax burdens, succession planning, and many others. The tax system can feel especially intimidating. In addition to managing the estate tax, estate planning can also help clients address income taxes.
One of the most effective ways to manage income taxes through estate planning is by addressing the step-up in basis at death. At death, certain assets, such as real estate, stocks, or other investments, may receive a “step-up” in their cost basis. Cost basis is essentially the original value of an asset for tax purposes, typically the purchase price. The step-up adjusts this basis to the asset’s fair market value on the date of death. But how does this help the beneficiaries who receive that asset?
Imagine you purchased a piece of property for $1,000,000 many years ago, and its value has appreciated to $5,000,000 by the time of your death. Under the step-up in basis rule, your beneficiaries would inherit this property with a cost basis of $5,000,000, not the original $1,000,000. If they decide to sell the property immediately, they would likely incur little to no capital gains tax, as the sale price would be close to the new stepped-up basis. Alternatively, if you sold the property before passing away in order to transfer cash to your beneficiaries, you would pay capital gains tax on the $4,000,000 increase in value between the sale price (assuming the actual price matches the fair market value) and the cost basis.
Key Benefits of the Step-Up in Basis:
- Significant Tax Savings: By resetting the basis of appreciated assets, the step-up in basis can eliminate substantial capital gains taxes that would otherwise be due upon the sale of inherited assets.
- Simplified Record-Keeping: Your beneficiaries won’t need to track the original purchase prices and adjustments over the years. The step-up provides a clear, current market value basis for tax purposes.
- Enhanced Estate Value: The step-up in basis can preserve more of your estate’s value for your beneficiaries because less will be lost to taxes.
Understanding the step-up in basis can help you make strategic decisions about which assets to retain in your estate. For instance, assets with significant appreciation might be better held until death to maximize the tax benefits for your beneficiaries. Conversely, assets with little or no appreciation might be more advantageous to sell or gift during your lifetime, utilizing annual exclusion gifts or lifetime gift tax exemptions. Keep in mind, however, that not all assets qualify for a step-up in basis. Retirement accounts, such as IRAs and 401(k)s, for example, do not receive this treatment. Additionally, it is crucial to consider your entire financial picture, your goals, and the specific needs of your beneficiaries.
Looking for the best way to maximize the use of your Estate Plan? Contact our team to discuss the best way to review or create an Estate Plan that works for your family.
About the Author
S. Blaydes Moore, JD 
Attorney