What does it mean to have a step-up in cost basis on an appreciated asset? (An appreciated asset could be a stock, bond, mutual fund, etc. that has gone up in value) For estate planning purposes, how is the gain on the asset taxed for the beneficiary? Pete Keller, CFP® of Pure Financial Advisors walks through stepped-up basis for beneficiaries, for spouses where the asset is held as joint tenants with rights of survivorship, and for spouses where the asset is held as community property.

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Step-Up in Basis Explained: What is Stepped-Up Cost Basis?

When it comes to understanding the tax implications of an inheritance or gifting property, the concept of “step-up in basis” becomes crucial. Step-up in basis, or stepped-up cost basis, refers to the adjustment of an asset’s value upon inheritance or gifting, which can have significant implications for tax liability. To grasp this concept fully, let’s delve deeper into what step-up in basis entails and how it can impact your financial situation.

In a nutshell, the cost basis of an asset is its value for tax purposes, usually determined at the time of acquisition. The step-up in basis occurs when the value of an asset is adjusted to its fair market value at the time of inheritance or gifting, rather than the original purchase price. This means that if you inherit an asset or receive it as a gift, your cost basis for tax purposes is reset to the asset’s value on the date of acquisition. This adjustment allows you to avoid capital gains taxes on the appreciation that occurred before the receipt of the asset.

For example, let’s say you inherit a family home originally purchased for $200,000, but its fair market value on the date of inheritance is $500,000. With a step-up in basis, if you decide to sell the property for $550,000, you would only be liable for capital gains taxes on the $50,000 difference between the sale price and the stepped-up basis. Without the step-up in basis, you would owe taxes on the $350,000 appreciation from the original purchase price.

The step-up in basis principle is particularly significant in situations where assets have appreciated significantly over time. Without it, heirs and recipients would face a much higher tax burden when selling inherited property. By resetting the cost basis to the fair market value at the time of inheritance or gifting, the step-up in basis helps to mitigate the tax impact on beneficiaries and provides an incentive for them to sell inherited assets without incurring substantial tax liabilities.

It’s important to note that step-up in basis primarily applies to assets subject to estate or gift tax. These assets may include real estate, stocks, bonds, or other investments. However, certain assets may not receive a step-up in basis, such as tax-deferred retirement accounts like traditional IRAs or 401(k)s. These accounts are subject to income taxes regardless of step-up in basis.

It’s essential to consult with a tax professional or estate planning attorney to fully understand the implications of step-up in basis based on your specific financial circumstances. They can guide you through the complexities of tax regulations and help you make informed decisions regarding inherited or gifted assets.

In summary, step-up in basis is a valuable tax provision that adjusts the cost basis of an asset to its fair market value at the time of inheritance or gifting. It helps heirs and recipients of assets reduce their tax liability by avoiding capital gains taxes on the appreciation that occurred before receiving the assets. Familiarity with step-up in basis can be immensely useful in estate planning and ensuring that you make informed financial decisions.