All About the Stepped-Up Basis Loophole - SmartAsset (2024)

FAQs

What is the stepped-up basis loophole? ›

The stepped-up basis loophole allows someone to pass down assets without triggering a tax event, which can save estates considerable money. It does, however, come with an element of risk. If the value of this asset declines, the estate might lose more money to the market than the IRS would take.

Stepped-up basis is a tax provision that allows heirs to reduce their capital gains taxes. When someone inherits property and investments, the IRS resets the market value of these assets to their value on the date of the original owner's death.

Examples of Assets That Do NOT Step-Up in Basis

Individual retirement accounts, including IRAs and Roth IRAs. 401(k), 403(b), 457 employer-sponsored retirement plans and pensions. Real estate that was gifted prior to inheritance. Tax-deferred annuities.

How Is It Calculated? The step-up in basis is just the difference between the item's current value and its cost basis at the time of purchase. So if you inherit a $150,000 property that was originally purchased for $50,000, the cost basis steps up $100,000 to the current value.

Stepped-up basis is an income-tax loophole. Closing it will not create a “second estate tax” or an additional tax of any kind. It simply will equalize the income tax treatment of appreciated assets sold prior to death with those held until death.

Due to the passing of the benefactor, the heir will receive a step up in basis to the fair market value at the time of the benefactor's death.

The step-up in basis provision adjusts the value, or “cost basis,” of an inherited asset (stocks, bonds, real estate, etc.) when it is passed on, after death. This often reduces the capital gains tax owed by the recipient.

Typically, assets you place in trust for your beneficiaries are eligible for a step-up in basis if the trust is revocable, and therefore considered part of your taxable estate. But with an irrevocable trust (which exists outside of your estate), trust assets do not receive a step-up in tax basis.

When you receive assets as a result of another person's death, your basis in the assets received is “stepped up” to the value of the assets at the date of death or, in some cases, the date that is 6 months after the date of death. This results in a very large tax savings when highly appreciated property is inherited.

Do I get a step-up in basis when my spouse dies? ›

Federal tax code section 1014(b)(6) provides that community property assets step up 100 percent in basis at the death of one spouse (even though the other spouse survives). Example: Stock worth $100 at date of death with a basis of $20 steps up to $100 basis upon date of death.

A recent Internal Revenue Service revenue ruling has finally settled the debate over whether the assets in an irrevocable grantor trust can get a step-up in basis at the grantor's death. Revenue Ruling 2023-2 makes clear that there's no step-up in basis.

If you make the inherited property your primary residence and live there at least 2 years before you sell it, you can qualify for an IRS capital gains exclusion (aka the Section 121 Exclusion). It's $250,000 for a single filer or $500,000 for a couple filing jointly.

Example of Step-Up in Basis

Let's say Robert purchased 200 shares of XYZ Co. stock at $50 apiece. Jennifer inherits the stock after Robert's death. At that point, the stock's price has climbed to $70 a share.

"You can elect step up in basis on the decedent's death." No, basis adjustment is mandatory, including a step down in basis if the fair market value on death is less than the decedent's basis in the asset.

When an investor passes away and rental property is inherited, the property basis is stepped-up and the heirs pay no tax on depreciation recapture or capital gains.

Rul. 2023-2, the IRS determined that the basis “step-up” under section 1014 does not apply to assets gifted to an irrevocable grantor trust by completed gift in cases in which such assets are not included in the gross estate of the owner of the trust for federal estate tax purposes.

Schedule D and Form 8949

A gain or loss is based on the step-up in basis, if applicable. Disposition of the property is reported on Form 8949. This form contains details such as the date it was acquired, the date it was sold, and a description of the asset.

The basis of property inherited from a decedent is generally one of the following: The fair market value (FMV) of the property on the date of the decedent's death (whether or not the executor of the estate files an estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return)).

Carryover basis calculates the capital gains of a gifted asset by using the purchase price of the original grantor. This is to be contrasted with a step-up basis for inherited assets which looks at the market value at the time of inheritance.

Is there a loophole for capital gains tax? ›

Stepped-up basis is a loophole exempting certain capital gains from the federal income tax. Wealthy investors are incentivized to hold assets until their deaths, even when switching to other investments might prove more productive. Capital gains are the increase in value of an asset that a person holds.

The seller must not have sold a home in the last two years and claimed the capital gains tax exclusion. If the capital gains do not exceed the exclusion threshold ($250,000 for single people and $500,000 for married people filing jointly), the seller does not owe taxes on the sale of their house.9.

You can't avoid capital taxes by reinvesting in real estate. You can, however, defer your capital gains taxes by investing in similar real estate property.

One of the most significant disadvantages of a trust is its complexity. Generally, trusts use very specific language, which can be difficult to understand for those who are not often involved in estate law. Because trusts were once written in Latin, there are many legal terms that still carry over.

The tax code of the United States holds that when a person (the beneficiary) receives an asset from a giver (the benefactor) after the benefactor dies, the asset receives a stepped-up basis, which is its market value at the time the benefactor dies (Internal Revenue Code § 1014(a)).

The purpose of an irrevocable trust is to move the assets from the grantor's control and name to that of the beneficiary. This reduces the value of the grantor's estate in regard to estate taxes and protects the assets from creditors.

The concept of step-up in basis is actually quite simple. A trust or estate and its beneficiaries, or payable on death beneficiaries, get a step-up in basis to fair market value of the asset so received. That value is stepped up to the fair market value of the asset as of the date of death of the Decedent.

Double Step-Up Basis

This means that a spouse is able to take the first step-up basis when taking over the property held in a revocable living trust with the other spouse. When the second spouse dies, the beneficiary would get the second step-up basis based on the date of death of the last living spouse.

Overview. When the grantor, who is also the trustee, dies, the successor trustee named in the Declaration of Trust takes over as trustee. The new trustee is responsible for distributing the trust property to the beneficiaries named in the trust document.

After the grantor of an irrevocable trust dies, the trust continues to exist until the successor trustee distributes all the assets. The successor trustee is also responsible for managing the assets left to a minor, with the assets going into the child's sub-trust.

How are trust assets distributed to beneficiaries after death? ›

Distribute trust assets outright

The grantor can opt to have the beneficiaries receive trust property directly without any restrictions. The trustee can write the beneficiary a check, give them cash, and transfer real estate by drawing up a new deed or selling the house and giving them the proceeds.

According to the Internal Revenue Service (IRS), federal estate tax returns are only required for estates with values exceeding $12.06 million in 2022 (rising to $12.92 million in 2023). If the estate passes to the spouse of the deceased person, no estate tax is assessed.318 Taxes for 2022 are paid in 2023.

The gift tax limit for 2022 was $16,000. This amount, formally called the gift tax exclusion, is the maximum amount you can give a single person without reporting it to the IRS.

Generally, the capital gains pass through to the heirs. The estate reports the gain on the estate income tax return, but then takes a deduction for the amount of the gain distributed to the heirs since this usually happens during the same tax year.

You usually get this information on the confirmation statement that the broker sends you after you have purchased a security. You—the taxpayer—are responsible for reporting your cost basis information accurately to the IRS. You do this in most cases by filling out Form 8949.

In order to calculate cost basis, you use either the value of the property on the date of the original owner's death or a date selected by the executor no later than six months after the death.

It's also worth noting that the step-up in basis doesn't just happen automatically. You'll need to fill out paperwork with the custodian if there wasn't a financial advisor managing the accounts. Inherited real property, like a house, will need to be appraised by a professional.

Typically, assets you place in trust for your beneficiaries are eligible for a step-up in basis if the trust is revocable, and therefore considered part of your taxable estate. But with an irrevocable trust (which exists outside of your estate), trust assets do not receive a step-up in tax basis.

A trust or estate and its beneficiaries, or payable on death beneficiaries, get a step-up in basis to fair market value of the asset so received. That value is stepped up to the fair market value of the asset as of the date of death of the Decedent.

What does Prop 19 do to inherited property? ›

Prop 19 requires that if the home is not used as a child's personal residence within one year, it is to be reassessed at market value when inherited.

When the assets are transferred to an heir, the beneficiary receives the property at a stepped-up basis that can eliminate these deferred gains. The step-up in basis also eliminates any downward basis adjustments that were claimed during the holding period of the asset, including amortization and depreciation.

Do assets owned in a trust receive a step-up in basis? Yes and no. If the asset was held in a revocable (or living) trust before the owner died, it will likely be eligible for a step-up in cost basis. Financial accounts aren't the only assets that can be held in trust.

This rule generally prohibits the IRS from levying any assets that you placed into an irrevocable trust because you have relinquished control of them. It is critical to your financial health that you consider the tax and legal obligations associated with trusts before committing your assets to a trust.