By Brittany Manning, CPA, CFP®, Director of Wealth Management Services
Asset values are an important piece of the estate planning puzzle as they can contribute to calculations of estate or inheritance taxes. Additionally, for beneficiaries, the asset values can sometimes leave them subject to exposure to large capital gains taxes on inherited assets. One aspect of the estate valuation process is the “stepping up” of an asset’s basis at the time of the owner’s passing.
Generally, when an asset is inherited, it retains the original basis from the owner. However, the tax code has a feature in it allowing for inheritors to claim an adjusted “stepped up” basis equal to the value at the time of the inheritance, thereby reducing their exposure to capital gains tax upon selling the asset.
A stepped up basis is an adjustment to an asset’s cost basis to the fair market value of the asset at the time of the decedent’s death. This adjustment provides a benefit to those who inherit the assets by lowering the amount of capital gains taxes that are due when the assets are later sold. The step up in basis can apply to inherited assets such as real estate, stocks, and bonds. To be able to qualify for the step up in basis, the assets must be owned by the decedent at the time of their death, either individually owned, owned jointly, or in a revocable living trust. Those assets jointly owned would qualify for one half of the value to be stepped up at the time of death, as that is what the decedent was considered to have owned.
For example, Joe purchased 10,000 shares in ABC Company for $5 each and owned them in his individual name. At the time of his passing, Joe still owned the shares, which were worth $20 per share when he died. Rather than his heirs potentially owing tax on $150,000 (the difference of cost basis in fair market value multiplied by 10,000 shares), they can adjust their basis in the inherited shares of ABC Company to $20 per share. Therefore, they receive the value of the shares if sold, $200,000, which equals their basis, and then owe no capital gains tax. If there was no basis adjustment, the $150,000 would be subject to capital gains taxes when sold.While this feature of the tax code is currently in place, there is always the possibility the tax laws will change in the future. The step up in basis has been helpful for many years for wealth transfer, by allowing inheritors to avoid capital gains taxes on some assets. With our holistic planning focus, MCF is here to help review your asset ownership and can discuss with you which assets will be subject to a step up at death and which would not. Your wealth can transfer more efficiently to your heirs with proper review and planning of asset ownership.
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