What the ‘Step-Up Basis’ Tax Rules Mean for Your Family
When you plan for what happens to your things after you die, it is important to understand how taxes might affect what your family receives. If you know the tax rules, you can help your family avoid paying more taxes than they need to.
Requirement for Executors
Sometimes, if you are in charge of someone’s estate, you have to tell the person who gets the property how much it is worth. This usually happens if you have to file a special tax form for the estate.
The Basics of Basis
When you buy something, your “basis” is how much you paid for it. This can also include additional costs such as sales tax or delivery fees.
If you get property from someone who has died, the amount used for taxes is usually figured out in one of these ways:
The fair market value (FMV) of the property at the date of the individual’s death.
The FMV on the alternate valuation date if the executor or personal representative for the estate chooses to use alternate valuation.
There are special valuation methods and rules for real property used in farming, closely held businesses, and qualified conservation easements.
Step Up, Step Down
The ‘step-up basis’ rule means that when you inherit something, its value for taxes is usually what it was worth when the person died. For example, if your grandfather bought stock for $500 a long time ago and it is worth $5 million when he dies, you only pay taxes based on the $5 million, not the small amount he paid.
The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, whether or not a federal estate tax return was filed. Those rules also apply to property inherited from foreign persons, who aren’t subject to U.S. estate tax. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his inheritance. The fair market value basis rules also don’t apply to fiduciaries’ reinvestments of estate assets.
If you know these rules, you can help your family avoid big tax bills.
For example, if your grandfather, instead of dying owning the stock, decided to make a gift of it in honor of his 100th birthday, the “step-up” in basis (from $500 to $5 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules: The donee takes the same basis the donor had in it (just $500), plus a portion of any gift tax the donor pays.
A “step-down,” rather than a “step-up,” occurs when a decedent dies owning property that has declined in value. In that case, the basis is reduced to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. In this case, however, giving the property away before death will not preserve the basis: When property which has gone down in value is the subject of a gift, the donee must take the date of gift value as his or her basis (for purposes of determining his loss on a later sale). The best idea for property that has declined in value, therefore, is for the owner to sell it before death so he can enjoy the tax benefits of the loss.
Although the above discussion refers to the date-of-death value, the value differs in some cases. Where the decedent’s executor makes the alternate valuation election, then the basis will be determined as of the date six months after the date of death (or, if the property is distributed or otherwise disposed of by the estate within the six-month period, the date of distribution or other disposition).
The problem with giving a low basis lifetime gift, including your house
Some people think about putting their house in a trust. But if you do this, you might lose a tax break that lets you avoid paying taxes on up to $250,000 (or $500,000 for a couple) when you sell your home.
If you give away property that has increased in value, the person who receives it might have to pay more in taxes. It is smart to talk to a tax expert before giving away valuable things.
Deathbed Maneuvers
One strategy considered by some taxpayers is to pass property through a decedent to attempt to inflate basis under the fair market value basis rules.
For example, let’s say you own stock with a $1,000 basis and $20,000 value. You go to your 97-year-old grandmother and arrange the following: You gift the stock to your grandmother, who takes it with your $1,000 basis. Then, your grandmother dies, leaving the stock back to you in her will. You regain ownership, but now with the basis stepped up to its $20,000 date-of-death value. However, under a rule to prevent this result, if your grandmother dies within a year of your gift, you still retain your original ($1,000) basis. The result is the same if, instead of leaving the stock to you, your grandmother leaves the stock to your spouse.
Knowing about basis can help you make better choices for your family’s future. If you want help with your estate plan, you can call Ronald J. Cappuccio, J.D., LL.M. (Tax), Counsellor At Law, at (856) 665-2121 to talk about your situation.
