A Brief Guide to Stepped-Up Cost Basis

A Brief Guide to Stepped-Up Cost Basis
A Brief Guide to Stepped-Up Cost Basis

Table of Contents

What is Stepped Up Cost Basis and how is it important?

Below is our brief guide!

In a nutshell, stepped-up cost basis saves you capital gains tax! What’s that? It’s the tax on the value of an asset paid when you sell it, based on the increase in that value (called the adjusted cost basis). It can be alleviated, however: when you inherit an asset, you inherit the value that exists at the time of death, a fact which can save you a mountain of cash.

Let me give you an illustration of how step-up works. Imagine you have a rich uncle, the one who wears a cowboy hat no matter the weather. Cowboy Hat Uncle bought a piece of real estate for $40,000 in 1930. Suppose he dies today, and the real estate is worth $800,000. Had he sold the real estate yesterday, he would have had to pay capital gains tax on the difference between the value when he bought it, and the value now.

But maybe, instead of selling it, Cowboy Hat Uncle wanted to give it to you. He could have done so in two ways.

  • Cowboy Hat Uncle could have gifted it to you before his death. If he did, not only might he have to pay a gift tax, but the real estate would also be gifted to you with the original cost basis. If you ever decide to sell it, you would have to pay the difference between the sold price and $40,000. That could be pretty pricy!
  • Cowboy Hat Uncle could have left it to you in his will. If he did, you could disregard the original cost basis, and instead report the “stepped-up cost basis” (in this case, $800,000) to the IRS. If you ever decide to sell it, you would only need to pay capital gains tax on the difference between the sold price and $800,000. That could be a LOT less than if he gifted it to you while he was still alive!

Choosing option 2) can mean saving hundreds of thousands of dollars. Too often I see situations in which clients gift property to avoid a probate, only for it to cost them far more than a probate ever did. There are instances where gifting makes sense, though describing them would take longer than this short article has time for.

As always, this is a short summary of a highly complex topic. Have your circumstances reviewed by your estate planning, probate, or trust attorney before making any decisions.

Addendum: As of 2021, there is talk among policymakers of adjusting stepped-up cost basis. Keep this in mind as you plan your estate, and when in doubt, consult an attorney for guidance.

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