The stepped-up basis is a provision in federal tax law that adjusts the value of an inherited asset for tax purposes. It means that the cost basis (the original purchase price) of the asset is increased to its fair market value on the date of the decedent’s death. This can lower or eliminate the capital gains tax liability for the heir who sells the asset later.
For example, suppose Jane bought a house for $100,000 in 1990 and died in 2022 when the house was worth $500,000. She left the house for her son John. John’s cost basis for the house is not $100,000 (Jane’s original purchase price), but $500,000 (the fair market value on Jane’s date of death). If John sells the house for $500,000, no capital gains taxes due. The stepped-up basis effectively eliminates the capital gain that occurred during Jane’s lifetime.
Real estate, stocks, and businesses are a few examples of assets that qualify for the stepped-up basis. However, some assets do not qualify for the stepped-up basis, such as: retirement accounts (such as IRAs and 401(k)s); annuities; and gifts during lifetime.
The stepped-up basis can have a significant impact on your estate planning strategy. It can help you minimize taxes for your heirs and maximize the value of your legacy. Here are some ways to use the stepped-up basis in estate planning:
• Hold on to appreciated assets until death. If you have assets that have increased in value over time, you may want to keep them until you die rather than sell them during your lifetime. This way, you can avoid paying capital gains tax on the appreciation and pass on the assets to your heirs with a stepped-up basis.
• Donate appreciated assets to charity. If you want to support a charitable cause and reduce your current taxes and taxable estate, you can donate appreciated assets to a qualified charity. The charity will also receive the asset with a stepped-up basis and can sell it without paying tax.
The stepped-up basis is a valuable tax benefit that can help you and your heirs save money on capital gains taxes when you pass on your assets. It can also influence your estate planning decisions, such as whether to hold or sell appreciated assets, or donate them to charity. However, the stepped-up basis may be subject to changes in the future, as some lawmakers have proposed to limit or eliminate it. Therefore, it is important to stay informed of the current tax laws and consult with an accountant and/or estate planning attorney to create a plan that suits your goals and circumstances.