When people pass on property to family members and other heirs, the concept of a step up in basis may affect the value of the property. While this concept is a little complicated, understanding it may cause you to make changes to your estate plan.
What Is a Step Up in Basis?
Basis refers to the value of an item. When you purchase real estate or another valuable asset, you acquire it at cost basis (the cost you paid for the asset). The basis may change if you transfer this property to another person, either during your lifetime or through your estate. Basis matters when you or your heir calculates taxes on the property.
When you transfer property to another person during your lifetime, the property receives a carryover basis. The original cost basis at which the purchaser bought the asset transfers over to the recipient. When the recipient eventually sells the property, he or she will have to pay capital gains taxes on the difference between the property’s value when the purchaser bought it and when the recipient sold it. Since the purchaser may have bought it many years ago and the value may have increased substantially since then, capital gains taxes could be quite high.
If you instead transfer property to an heir through your estate, the cost basis receives a “step up”. The recipient receives the property with a basis of its fair market value at the time of your death. There is no carryover of the cost basis. As a result, the recipient will not have to pay capital gains tax on any increase in the property’s value from the time the purchaser bought it until his or her death. The only capital gains tax assessed will be for the time between the purchaser’s death and when the recipient sells it.
Why Step Up in Basis Matters for Estate Planning
As you can see, lifetime gifts might result in substantially more capital gains taxes for recipients than gifts through an estate plan. However, there are other good reasons to make lifetime gifts, such as decreasing the value of your taxable estate, taking advantage of yearly estate tax exclusions, and the like.
Evaluating whether to give property to your heirs now or later may depend on the property’s value compared to when you bought it, as well as any predicted changes in value over the rest of your lifetime. It can be tricky to figure out which method of giving is most beneficial for both you and your heirs.
Some estate planning structures, such as certain trusts, can take advantage of steps up in basis and other tax issues. Maximizing your use of these structures is complicated, usually requiring the help of an experienced estate planning attorney. If you want to know more or have questions, contact an attorney in your area.
Planning your estate? Look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet’s more than 20 years of legal experience will give you confidence and peace of mind. To schedule a “Get Acquainted” meeting, visit Janet's website or call her office at (650) 469-8206.
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