When an individual inherits assets after a loved one passes away, assets often transfer with a valuable, but frequently misunderstood, tax benefit called the step-up in basis. Below is an overview of how this rule works and what planning may be done.
WHAT DOES “BASIS” MEAN?
Basis is generally what the owner paid for an asset after adjustments. In the case of tangible property, adjustments include improvements and depreciation. In the case of stock, adjustments include dividends reinvested, return of capital, etc. Generally capital gains (losses) result from the selling price of the asset after adjustments.
At the death of an owner, many capital assets (stock, real estate, business interests, collectibles, crypto, etc.) are stepped up (or down) to the asset’s fair market value (FMV) as of the date of death of the owner. The heir’s new basis is that FMV, eliminating the tax on any unrealized gain or loss that accumulated during the deceased person’s life. This produces an the opportunity for enormous tax savings.
For example, an individual bought stock years ago for $50,000. At their death, it’s worth $220,000. The inherited basis is $220,000. If the heir sells immediately for $220,000, there’s no capital gains tax. If the heir holds it and sell later for $260,000 and they only recognize the $40,000 gain since the date of death.
There are many additional rules heirs / beneficiaries should be aware of:
- Some assets are not eligible for a stepped-up basis. For example, 401(k)s and IRAs are excluded.
- In some cases, an executor of an estate can elect an alternate valuation date, six months following the date of death.
ACTIONS FOR HEIRS AND FUTURE ESTATES
There are some steps that heirs and individuals planning their estates can take.
After a death, heirs should:
- Document the FMV of assets on the date of death. Brokerage statements, appraisals, common real estate site printouts, cryptocurrency exchange screenshots, etc. are all helpful.
- Retitle assets into the heir’s name or trust as soon as possible to avoid administrative issues.
- Keep meticulous records for when the heir sells assets years later for support should the IRS raise questions.
- Consider seeking an independent appraisal for hard to value assets such as privately held business interests, collectibles, etc.
Asset owners planning should include:
- Provide an inventory of assets for heirs.
- Recognize capital losses while living to avoid the step down that will occur at death.
- Coordinate gifting and lifetime transfers. Gifts use a carry-over basis. This means gift (rather than an inheritance), basis is generally the same as the donor’s was when the gift was made.
GOOD RECORDS AND PROACTIVE PLANNING
These are some of the basic rules. Other rules and limits may apply. Gifts made just before a person dies (sometimes called “death bed gifts”) may be included in the gross estate for tax purposes. Reach out to us for tax assistance when estate planning or after receiving an inheritance. We’ll help you plan the most tax-efficient path forward.
