How Does A Step Up In Basis Work?

How Does A Step Up In Basis Work?

Capital gains taxes are one of the more confusing taxes that American citizens have to pay.  The best way to explain capital gains taxes is through examples.  This article will include plenty of examples, but in an attempt to define these taxes, capital gains taxes are the tax accessed on an asset when it is sold and has increased in value.

Capital gains taxes are a percentage of what a person buys the asset for (the “basis”) and what the amount the property was sold at (the “step-up”).    Most assets have a tax basis, and generally, this is the amount a person paid for the property originally.   When you inherit an asset, the basis is usually set at the amount the property is worth on the day of the transfer.

It is important to know how much an asset is worth on either the day the asset was purchased or on the day the owner dies and the property is transferred.  Once the property is sold, the tax will be accessed on the difference between the first value and the amount the property was sold for.  Most people pay about 15 percent on the difference.  Higher earners may have to pay as much as 23.8 percent capital gains tax.

What is a stepped-up basis?

As we explained earlier in this article, an asset’s basis can be set at its value of the date of the owner’s death.  This means that the property’s basis is no longer the amount the property was purchased for, and instead, the property is set at the basis upon the owner’s death.  This can equal a lot of tax savings!

For example, property X is worth $10 in 1945 when Andrew buys it.  Andrew drafts a will and leaves the property to his son Ben upon his death.  Andrew then dies in 2000, and the property is now worth $100.  In 2017, Ben decides to sell the property for $150.  The capital gains tax would be a percent of the difference between the value in the year 2000 (value as of the date of death) and the value in 2017, which would be $50.  Without the stepped up basis, Ben would pay the difference between the property’s value in 1945 and 2017, which would be $140  ($150 less original purchase price of $10).  Say Ben would be taxed at 15 percent.

This stepped up basis could be the difference between him paying $7.50 or $21.00.  Of course in real life, these amounts could be much greater for assets such as houses and stocks.  Stocks and bonds are more difficult to determine the basis as of the date of death.  The brokerage company needs to generate an estate valuation report, which averages the high and low trading value for each stock and bond on the day the owner died.

Not all assets get a step-up in basis at the death of the owner.  For instance, retirement assets such as IRAs and 401(k)s don’t get a step-up.  Assets held in a bypass trust also do not receive a step-up.

A step-up in basis is one of the greatest estate planning tools in the toolbox.  For more information on how your estate plan can utilize the step-up in basis to avoid costly capital gains taxes call the Jacksonville estate planning lawyers at The Law Office of David M. Goldman PLLC today at 904-685-1200.

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