Should I worry about a step-up in basis during my estate planning?

Taxes are a common concern when building a comprehensive estate plan, but there are ways to reduce the amount of taxes your children will have to pay on their inheritances. One such method is a step-up in basis, which can save your heirs a substantial amount of tax on assets that have gone up in value over time.

Inheritances and Capital Gains Tax

If you are leaving someone a property worth significantly more now than when you purchased it, the property will be subject to capital gains tax. Capital gains tax is assessed on the amount of profit an heir makes on the asset—in other words, the difference between the purchase price and fair market value at the time of inheritance.

Capital gains tax can also be assessed during a person’s lifetime. For example, imagine you purchased a stock for $10. Four years later, the stock is worth $200. If you decide to sell, you would have to pay capital gains tax on $190.

Another complication is that the capital gains tax rate is higher than other types of taxes. The exact rate will depend on how long you held the asset before selling.

Short-term. If you hold an asset for less than a year, your profits will be taxed at the short-term capital gain rate—the same as your ordinary income tax level.
Long-term. If you hold an asset for a year or more, your profits will be taxed at the long-term capital gain rate of 0% to 20%. Inherited property is usually treated as a long-term capital gain.

As you can see, high-value assets can bring an influx of wealth to your heirs, but they can also cause a significant tax expense. Fortunately, there’s a way to reduce the total amount of taxes owed: the step-up basis.

Step-Up in Basis Reduces Inheritance Tax Burden

A step-up in basis lowers the amount of taxes by “resetting” the cost basis. Instead of using the asset's original purchase price as the basis, heirs can use the property’s fair market value on the date of the original owner’s death. The adjusted higher value makes the taxable profit smaller, resulting in a smaller capital gains tax bill.

Save on Taxes With a Customized Estate Plan

Current tax laws allow step-up in basis to avoid capital gains taxes and gifting exemptions to minimize estate taxes. Since these laws are constantly changing, it pays to have your estate plan evaluated every few years by a knowledgeable and experienced attorney. Contact Landskind & Ricaforte Law Group, P.C., today at (718) 333-5007 or through our online form to learn how we can help you.

Which Assets Can Be Stepped Up?

Almost everything you own and use for pleasure, investment, or personal purposes can be considered a capital asset. The step-up is for capital assets expected to appreciate in good market conditions.

Common capital assets that can be stepped up include:

Your home

Household furnishings

Stocks

Bonds

Vehicles

Real estate

Jewelry or gems

Precious metals like gold or silver

Coin or stamp collections

Full or part ownership of a business

Timber grown on your property

It’s important to note that 401K accounts, IRA accounts, annuities, and pensions are all exempt from step up in basis.

Who Benefits From a Step-Up in Basis?

Generally speaking, your spouse, beneficiaries, and anyone who inherits property through your line of succession could save enormous sums with a step up in basis. Tax planning performed at your passing might benefit your family for decades into the future, including:

Your spouse. There is a capital gains income exemption of up to $500,000 on a primary residence for a married couple filing jointly. If your spouse sells your family home, they can keep up to half a million dollars in profit without paying capital gains.

Your children. Not only does your spouse receive a new cost basis on everything they inherit, but there may be a second step-up in the tax basis when your spouse passes away. If the house in the example above is kept in the family until the second spouse passes away, the house is stepped up again, and the heir decides to sell the home a month after inheriting it. Since the value hasn’t increased at all from the date of passing, there are no capital gains taxes.

Your grandchildren. Property can be kept in the family for generations without capital gains tax as long as the value is stepped up each time it changes hands. If your house passes to your grandchildren—or your grandchildren’s children—they will only have to pay capital gains taxes on the appreciation in the property’s value from the date of their surviving parent’s death.