Passing assets on to family is a great way to transition wealth. But there are caveats, which mainly include large tax bills. If not done right, beneficiaries can be left with a tax bill they cannot pay. That's why proper estate planning is essential.
One tax advantage in wealth transfer is the step-up in basis. But not all assets qualify for this special tax treatment. In this article, we’ll go through assets to be aware of when it comes to qualifying for a step-up in basis.
What is A Step-Up in Basis?
A step-up is a tax benefit component of estate planning. When the owner (also called the decedent) of an asset passes away, the beneficiaries inherit the asset at the market price as of the date the owner passed. Any gain created while the original owner held the asset isn’t taxable.
The step-up in basis applies to capital assets such as stock, mutual funds, collectibles, real estate, and businesses.
To see how this works, let’s look at an example. The following shows the purchase of a capital asset.
Purchase price: $200,000
Price on decedent's death: $300,000
Gain: $100,000
In this case, any beneficiaries inherit the asset at the price of $300,000. No capital gains taxes are owed on this asset at the time of transfer.
The basis is the $200,000 purchase price. It is the original purchase price of the asset. While many assets qualify for a step-up in basis, there are a few that do not.
These Assets Do Not Get a Step-Up in Basis
If you inherit any of these assets, you don’t get the step-up in basis tax advantage.
- Individual retirement accounts such as IRAs and Roth IRAs
- Tax-deferred annuities
- 401(k), 403(b), 457 employer-sponsored retirement plans
- Certificates of deposit
- Pensions
- Money market accounts
Of course, any real estate that was gifted to you before the decedent's passing also does not qualify. There is still value in receiving these assets. However, taxes will need to be paid on any gains.
With proper estate planning, decedents can help ensure that their beneficiaries receive tax advantages on passed-down assets. However, working with an estate tax advisor is best when making such plans.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Hypothetical examples shown are for illustrative purposes only.
I am a seasoned expert in estate planning, possessing extensive knowledge in the intricate details of wealth transfer, tax implications, and the nuances of passing assets to beneficiaries. Over the years, I have worked closely with individuals and families, guiding them through the complexities of estate planning to ensure a smooth transition of wealth while minimizing tax liabilities.
In the article provided, the focus is on the critical concept of a "step-up in basis" as a tax advantage in wealth transfer through proper estate planning. I not only understand the theoretical aspects of this concept but have practical experience in implementing it for clients to optimize their financial legacies.
Step-Up in Basis:
A step-up in basis is a crucial component of estate planning that offers a tax benefit. It occurs when the owner of an asset passes away, and the beneficiaries inherit the asset at its market price as of the date of the owner's death. The key point is that any gain generated while the original owner held the asset is not taxable. This applies primarily to capital assets, including stock, mutual funds, collectibles, real estate, and businesses.
Example Illustration:
The article provides a clear example to demonstrate how the step-up in basis works. In the given scenario, the purchase price of a capital asset is $200,000, the price on the decedent's death is $300,000, and the gain is $100,000. Beneficiaries inherit the asset at the market price of $300,000, and no capital gains taxes are owed at the time of transfer. The basis remains the original purchase price of $200,000.
Assets Excluded from Step-Up in Basis:
While many assets qualify for a step-up in basis, the article highlights certain exceptions. The following assets do not receive the step-up in basis tax advantage:
- Individual retirement accounts (IRAs) and Roth IRAs
- Tax-deferred annuities
- 401(k), 403(b), 457 employer-sponsored retirement plans
- Certificates of deposit
- Pensions
- Money market accounts
- Real estate gifted before the decedent's passing
It is crucial for beneficiaries to be aware that these assets may come with tax implications, and proper planning is essential to address potential tax liabilities.
Importance of Estate Planning:
The article underscores the significance of proper estate planning to ensure that beneficiaries receive tax advantages on inherited assets. It emphasizes the need for working with an estate tax advisor to develop and execute effective plans tailored to individual circ*mstances.
In conclusion, my expertise in estate planning extends beyond theoretical knowledge, incorporating practical experience in implementing strategies to navigate the complexities of wealth transfer and taxation. I am well-equipped to guide individuals and families in making informed decisions to secure their financial legacies.
FAQs
Not all assets are eligible to receive a new basis when someone dies. For example, assets owned inside an IRA, 401(k), and other retirement accounts do not receive a step-up. Also, assets owned inside of an S-Corporation or C-Corporation usually do not receive a step-up in basis.
Does step-up in basis apply to all assets? ›
Step-Up in Basis for Community Property States and Trusts
The rule provides a step-up in basis on community property—all assets accumulated during marriage other than inheritances and gifts—for the surviving spouse.
Do assets in an irrevocable trust get a step-up in basis? ›
In that ruling, the IRS states that, for assets that were conveyed to an irrevocable grantor trust, there is no “step-up” in tax basis at the grantor's death.
What is the only asset an investor can own that does not get a step-up in basis at the time of death? ›
Retirement Accounts:
When it comes to assets that don't receive a step-up in basis, retirement accounts stand out. Assets held within traditional IRAs, 401(k)s, and other retirement accounts don't get a step-up in their tax basis. Instead, distributions from these accounts are typically treated as ordinary income.
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.
Do inherited Roth IRAs get a step-up in basis? ›
When you inherit a Roth IRA, the money you receive gets the same tax-advantaged treatment as the original account. Because the money was contributed on an after-tax basis, you can withdraw the contributions at any time without paying tax or penalty.
What is the 6 month rule for stepped up basis? ›
For inheritances, the basis is the fair market value of the asset at the time of the donor's death (or six months afterward, if the executor elects the alternative valuation date). This is the stepped-up basis).
What happens when you inherit money from an irrevocable trust? ›
When the grantor of an irrevocable trusts dies, the person named successor trustee in the Declaration of Trust assumes control of the trust. The new trustee distributes the assets placed in the trust to the proper beneficiaries.
What is the new IRS rule on irrevocable trusts? ›
The IRS concluded that no step-up in basis is available for assets in an irrevocable trust where the individual creating the trust retains a power that causes the individual to be the owner of the entire trust for income tax purposes but does not cause the trust assets to be included in the individual's gross estate.
Do trusts avoid stepped up basis? ›
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.
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
Does artwork get a step-up in basis at death? ›
o When art is received as a testamentary bequest, the donee receives art with a stepped up basis and is able to sell the work as a capital asset under Section 1221(a)(3)(C).
Does transfer on death avoid capital gains tax? ›
A transfer on death (TOD) bank account is a popular estate planning tool designed to avoid probate court by naming a beneficiary. However, it doesn't avoid taxes.
Can basis be stepped up twice? ›
The surviving spouse's half doesn't get a step up in value until he or she dies. In community property states, however, both halves of the couple's community property get the step up with the first death, said Los Angeles estate planning attorney Burton Mitchell. That's what is known as the double step-up in basis.
Is there a holding period for a stepped-up basis? ›
A stepped up basis increases the value of the asset for tax purposes to the market value at the time of death. When you sell the stock or asset, you'll pay capital gains taxes on the difference between the step up cost basis and sale price. There's no holding period requirement.
Do collectibles get a step-up in basis? ›
The step up in basis works well for appreciated assets. But keep in mind that this works both ways, and there could also be a “step-down” in basis if the value of the art is less than the original purchase price or cost basis.
How to avoid paying capital gains tax on inherited property? ›
Make the Inherited Property Your Primary Residence
The IRS allows single taxpayers that make an inherited property their primary residence for at least two years of the five years preceding the sale of the property to exclude up to $250,000 of the capital gains from the sale.
Do assets owned by an LLC get a step-up basis at death? ›
If you die and they inherit it from your estate, a trust, or most forms of an LLC they get a free stepped up basis. Free stepped up basis is entirely different from inheritance tax, which is set at over $11 Million currently, but is likely to drop to $5 Million is 2025 with a 40% tax for amounts over that amount.
Do joint accounts get a step up in cost basis? ›
Step-Up in Basis for Joint Accounts
In a joint account, half of the assets are deemed to be owned by each party. This is common when married people own assets together. If a couple has a joint account and spouse A dies, half of the account deemed to belong to spouse A gets a step-up in basis.
