Overview of the Basis Step-UpThe tax concept of basis and how it applies to transferring an asset is an important consideration when thinking about your estate plan. Transferring an asset at the wrong time can result in a significant increase in tax liability. Proper planning around basis can avoid these pitfalls and maximize your tax savings.
What is Tax Basis?
The tax basis of an asset is typically the amount of the owner’s capital investment in the property for tax purposes. In other words, your basis in an asset is how much that asset has cost you. Cost includes purchase price, sales tax, and other expenses connected with the purchase.
In addition, your basis can be adjusted upwards or downwards during the lifetime of the asset. For instance, costs of improvements that add to the value of real property will increase your basis, whereas depreciation on such an asset will decrease your basis. If you acquire property through gift or inheritance, your basis is typically transferred to you from the prior owner and may be adjusted.
Understanding your basis in an asset is essential in calculating your gain or loss on a sale or other transfer of property.
Basis Step-Up at Death
Under Section 1014(a)(1) of the Internal Revenue Code, property that passes by bequest, devise, or inheritance from a decedent receives a basis equal to the fair market value of the property at the date of the decedent’s death. This means that the basis of the asset is adjusted to equal the fair market value of the asset. For instance, if the decedent died owning a home with a basis of $500,000 and the fair market value of the home was $1,000,000 at the decedent’s death, the basis will be adjusted upwards to $1,000,000.
This “step-up” in basis can be a useful tool when it comes to tax and estate planning, especially if you reside in a community property state.
Surviving Spouses’ Share of Community Property
Under section 1014(b)(6) of the Internal Revenue Code, both the surviving spouse’s one-half share of community property and the deceased spouse’s one-half share of community property is considered property acquired from or passed from the decedent for the purposes of basis revaluation. Therefore, both shares of community property receive a step-up in basis on the deceased spouse’s death. The property then receives another step-up in basis at the surviving spouse’s later death. As a result, community property assets receive a “double step-up in basis.” This basis step-up is automatic and does not require one to file an estate tax return.
Obtaining a step-up in basis can result in significant tax savings because the asset can be sold with little or no capital gains tax shortly after the decedent has passed away. If you are considering transferring an asset during your lifetime or at your death, you should speak with a qualified professional to determine how the basis step-up can be utilized in your estate plan.
For more information on Estate Planning, contact BakerAvenue to discuss how we can help you start to think about an estate plan or navigate the complexities of basis step-up.