Ok, this is a little stretch, but it opens the door for the subject of Step-up in Basis for estates. As the novelty 1979 Christmas song goes, grandma died being run over by Santa’s reindeer with Claus marks on her back. With her passing, grandpa gets a step-up in basis on all their assets. If you inherit assets after a loved one passes away, they often arrive with a valuable — but frequently misunderstood — tax benefit called the step-up in basis. Below is an overview of how the rule works and what planning might need to be done.
What “Basis” means
First, let’s look at a couple definitions. Basis is generally what the owner paid for an asset, adjusted for improvements, depreciation, return of capital, etc. Capital gain (or loss) equals the sale price minus the basis.
At death, many capital assets (stocks, real estate, business interests, collectibles, crypto, etc.) are stepped up (or down) to their fair market value (FMV) as of the date of death (or, if elected by the executor, the “alternate valuation date” six months later). The heir’s new basis is that FMV, erasing the tax on any unrealized gain or loss that accumulated during the deceased person’s life.
For example, say your father bought ABC stock many years ago for $50,000. At his death, it’s worth $220,000. Your inherited basis is $220,000. If you sell immediately for $220,000, there’s no capital gains tax. Hold it and sell later for $260,000 and you’ll only recognize the $40,000 gain since the date of death. In the case of the song, grandpa got a step-up in the basis in their home that grandma was headed to before the accident. If they lived in Northern California and they bought the home in the 1960s for $300,000 and at death it was worth $3 million, then the tax on sale if grandpa sold within a year of grandma’s passing would be zero – not almost $95,000 – leaving grandpa almost $2.9 million to move into a retirement community nearby with money for his needs for the rest of his life.
Some assets don’t receive a stepped-up basis. For example, 401(k)s and IRAs are excluded. These accounts, as well as Installment sales that are Receivables at the date of death, are categorized as, “income in respect of a decedent”. If there is an estate tax paid by the estate these assets get to use their share of the tax as additional basis.
Actions for heirs and future estates
There are some steps that heirs and individuals planning their estates can take. For simple estates that are under $10 million and not likely subject to estate tax the following are practical recommendations.
After a death, heirs should:
· Document the FMV of assets on the date of death. You can use brokerage statements, appraisals, Zillow printouts, cryptocurrency exchange screenshots, etc.
· Retitle assets into your name or trust as soon as possible to avoid administrative issues.
· Keep meticulous records. You may sell years later, or the IRS may question you.
If the estate is larger than $10 million, contact your Hood & Strong advisor or attorney for the best way to support the valuations for a potential IRS estate tax audit.
Asset owners planning ahead should:
· Inventory low-basis assets you plan to hold and include in your estate.
· Harvest losses strategically to offset gains you can’t eliminate through a step-up.
· Coordinate gifting and lifetime transfers. Remember that gifts use a carry-over basis. This means if you are given a gift (rather than an inheritance), your basis is generally the same as the donor’s was when the gift was made.
Good records and proactive planning
These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. And gifts made just before a person dies (sometimes called “death bed gifts”) may be included in the gross estate for tax purposes.
Going back to the song and this step-up matter, “asked about believing in Santa, as for me and grandpa, we believe.”
Reach out to your H&S team for tax assistance when estate planning or after receiving an inheritance. We’ll help you chart the most tax-efficient path forward.
