How Does a Step-Up in Basis Benefit My Estate Plan?

Although your focus may be on deciding how to distribute your assets when you are creating your estate plan, you should also be aware of the impact taxes may have on your estate and on the gifts you leave behind for loved ones. Specifically, you need to understand how capital gains taxes could significantly diminish the value of assets you pass down to beneficiaries. Fortunately, there are estate planning tools and strategies that may help prevent taxes from impacting an inheritance. To help you better understand, the Indianapolis attorneys at Frank & Kraft discuss how a step-up in basis can provides benefits within your estate plan.

Capital Gains Taxes and “Basis” in Property

When calculating taxes potentially due on assets, the term “basis” refers to the value used to determine that tax obligation. Specifically, the term basis is used when calculating capital gains taxes which may be due when an asset is sold and a gain is realized on the sale, meaning you sold the asset for more than what you paid for it when you acquired it. Imagine, for example, that you purchased 100 shares of stock 10 years ago and paid $10 per share, or $1,000 in total. Today, that stock is worth $50 per share, making your 100 shares worth $5,000. If you sell that stock, you realized a gain of $4,000 ($5,000 – $1,000 = $4,000). While the rules regarding when capital gains taxes apply are complicated, if capital gains taxes are applicable, you will owe taxes on the $4,000 in realized gain.

What Does It Mean to Use a “Stepped-Up” Basis?

The basis in property can be extremely important when crafting your estate plan because capital gains taxes can dramatically diminish the value of a gift. For instance, imagine that you purchased the family home 40 years ago and paid $20,000 for the home. Today, that home is worth $400,000. If you gift the home to your adult daughter, and she sells the home, the gain realized is a staggering $380,000 using your original basis in the home. At a tax rate of 15 percent, your daughter would owe $57,000 in capital gains taxes. This is where the benefit of using a step-up in basis comes in handy.

As it applies to estate planning, a “step-up” in basis allows a beneficiary to use the value of an asset at the time of inheritance instead of using the donor’s original basis. In the above example, your daughter would receive a step-up in basis to $400,000 when she inherits the family home. If she sells the home in the future, her basis will be $400,000 instead of $20,000, dramatically reducing the amount of capital gains taxes owed.

Stepped-Up Basis and Jointly Owned Assets

If an asset is jointly owned, calculating the potential tax implications becomes more complicated. In most states, the default method is to treat jointly-owned assets as “separate property” for tax purposes. As such, the amount that is included in a decedent’s estate is only 50 percent of the assets’ value, meaning only 50 percent of the value of the property will be eligible for a “step-up” in the basis. The remaining 50 percent, (the surviving spouse’s half) keeps the original basis.

In our example from above, assume that you co-own the home with your spouse and that your spouse passes away, leaving her interest in the home to you. Her half of the value of the original basis in the house will receive a step-up in basis. In other words, her $10,000 (half of the original basis) will increase to half of the current value of $400,000. You now have her stepped-up basis of $200,000 plus your original basis of $10,000 for a basis of $210,000 despite the fact that the home is currently valued at $400,000. If you sold the home for $400,000, you would realize a gain of $190,000 upon which capital gains tax would be levied.

Do You Questions about How a Step-Up in Basis Will Impact Your Estate Plan?

For more information, please join us for an upcoming FREE seminar. If you have additions questions or concerns about how a step-up in basis can benefit your estate plan, contact an experienced Indianapolis estate planning attorney at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.

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