Step Up Basis In Estate Planning

A step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance. The higher market value of the asset at the time of inheritance is considered for tax purposes. When an asset is passed on to a beneficiary, its value is typically more than what it was when the original owner acquired it. The asset receives a step-up in basis so that the beneficiary’s capital gains tax is minimized. A step-up in basis is applied to the cost basis of property transferred at death. Tax basis is the amount of a taxpayer’s investment in property for tax purposes, typically used to calculate figure depreciation, amortization, and other property dispositions. A step-up in basis reflects the changed value of an inherited asset.

For example, an investor purchasing shares at $2 and leaving them to an heir when the shares are $15 means the shares receive a step-up in basis, making the cost basis for the shares the current market price of $15. Any capital gains tax paid in the future will be based on the $15 cost basis, not on the original purchase price of $2.

The step-up in basis rule changes tax liability for inherited assets in comparison to other assets. For example, Sarah bought a loft in 2000 for $300,000. When Paul inherited the loft after Sarah’s death, the loft was worth $500,000. When Paul sold the loft, his tax basis was $500,000. He paid taxes on the difference between the selling price and his stepped-up basis of $500,000. If there wasn’t a step-up in basis then Paul would have to pay taxes on the difference between the selling price and the initial buying price of $300,000.

Step-Up in Basis for Community Property States

Residents of community property states may take advantage of the double step-up in basis rule. For example, Allan and Jo Ann bought a home in 1977 for $350,000. They had a revocable living trust established and deeded the house to the trust. When Allan died in 2006, the house stayed in the trust, and Jo Ann received the step-up in basis for the home’s market value of $500,000. When Jo Ann passed away in 2015, the couple’s daughter Stephanie inherited the home. The home’s market value of $700,000 became her cost basis. Stephanie inherited a home that stepped up in basis twice and avoided paying a large amount of taxes because of the double step-up rule.

Step-Up in Basis as a Tax Loophole

The step-up in basis tax provision has often been criticized as a tax loophole for the ultra-rich and wealthy. They take advantage of it to eliminate or reduce their tax burden. For example, they can escape capital gains tax on stocks by placing their holdings in a trust fund for their heirs.

In a typical case, a millionaire might invest in assets, such as real estate and stocks that are expected to appreciate and provide them with a consistent rate of return during their lifetime. The investor’s heirs will enjoy the benefits of the investment after their death because they will be taxed on the stepped-up cost basis, instead of the original cost, thereby allowing them to evade taxes worth millions of dollars.

Example of a Step-Up in Basis

A person inheriting mutual funds receives a step-up in basis for the funds’ value. The price of the shares on the day the owner dies becomes the heir’s cost basis. The heir provides the mutual fund company proof of identity along with a death certificate, probate court order or other documentation. The company either transfers the shares to an account in the heir’s name or sells the shares and sends the proceeds to the heir.

A step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance. If an investor bought a loft in 2000 for $300,000 and, when it was inherited by the beneficiary, it was worth $500,000. So, the beneficiary’s tax basis will be $500,000. The beneficiary sells the loft for $750,000 which means that they will have to pay taxes on the difference between the selling price of $750,000 and their stepped-up basis of $500,000, or $250,000. A step-up in basis is applied to the cost basis of the asset transferred at death and the higher market value of the asset at the time of inheritance is considered for tax purposes. When an asset is passed on to a beneficiary, its value is usually more than what it was when the original owner acquired it. So, a step-up in basis typically minimizes the beneficiary’s capital gains tax if they were to dispose of that asset.

In the above example, if there wasn’t a step-up in basis then the beneficiary would have to pay taxes on the difference between the selling price of $750,000 and the initial buying price of $300,000, or $450,000. The step-up in basis tax provision has often been criticized as a tax loophole for the ultra-rich and wealthy as they could take advantage of it to eliminate or reduce their tax burden. For example, they can escape capital gains tax on stocks by placing their holdings in a trust fund for their heirs. Over the years, economists have proposed eliminating step-up in basis and have suggested that it could be replaced with lower capital gains taxes, but, as of yet, these changes have not been implemented. While creating your family’s estate plan, you may find yourself weighing the pros and cons of various strategies. The priorities for each family are different. Some are focused on the care of their family members after they are gone. Others are primarily concerned with who should receive specific assets. Different priorities could include minimizing taxes, protecting wealth from creditors, or encouraging beneficiaries to pursue certain activities, such as educational pursuits. Regardless of your family’s chosen priorities, your estate-planning attorney can create a plan that helps accomplish your goals.

Those concerned with the tax impact of transferring assets to their beneficiaries may be relieved to know that our tax system allows for a step-up in basis for some items. The basis in the asset is equal to its fair market value at the time of your death, rather than the amount that you paid for it during your life. This means that your loved ones could potentially avoid, or at least minimize, capital gains tax. Taking advantage of this step-up in basis can be a valuable tool as you create your estate plan.

Assets That Qualify for the Stepped Up Basis

Not all assets are eligible for the step-up in basis upon your death. Following are several examples of assets that do qualify:
1. Stocks
2. Mutual funds
3. Bonds
4. Businesses
5. Equipment
6. Real estate

Assets That May Not Be Eligible for a Step-Up in Basis

Following are examples of assets that will not receive a step-up in basis upon the owner’s death:
• IRAs
• 401(k) accounts
• Pensions
• Tax deferred annuities
• Certificates of deposit
• Money market accounts

Wills, Living Wills, and Trusts

A will can help make the transition after a loss as painless as possible for your loved ones. Your property will be transferred quickly and many tax burdens can be avoided. Wills typically describe the estate, name individuals who will receive specific property, and dictate any special instructions you may have. Depending on your wishes and the size of your estate, your will could be anywhere from a single page to a lengthy document. While a will allows you to express your financial wishes once you’re gone, a living will expresses your health care preferences while you’re still alive. With a living will, you’ll be able to designate the medical treatment you wish to receive, should you become unable to communicate your wishes due to illness or incapacitation. A health care power of attorney, on the other hand, allows you to designate a person who can make medical or end-of-life decisions on your behalf.

Trusts are another estate planning tool you can use to manage your property and avoid tax burdens. A trust can either be created during a person’s lifetime, or after death, by a will. There are a number of different types of trusts serving a wide range of functions. An asset protection trust, for example, is designed to protect a person’s assets from future creditors. A charitable trust, on the other hand, is used to benefit a particular charity or cause.

Estate Planning Lawyers

An estate planning attorney can help you in a number of different ways. If you’re interested in creating a will or setting up a trust, an estate planning attorney can draft the necessary documents and help lay the legal groundwork for your plan. That way, your loved ones will be able to avoid the costly and time-consuming probate process. In addition, if you’d like to express your wishes regarding medical treatment, an estate planning attorney can help you draft a living will or a health care power of attorney. If a loved one dies without a will, on the other hand, probate could be necessary. Probate is the court-supervised process of sorting out a person’s affairs. If that’s the case, it may be important for you to find an experienced probate attorney. An estate planning attorney will be able to guide you through the probate process and represent your interests in court.

There are a lot of steps that go into creating a complete Estate Plan.
1. Gather your assets. Inventory everything you own, from cars to collectibles.
2. Protect your family. Think about if you have adequate life insurance to leave your family in a position where they could maintain the life you currently lead.
3. Determine the plan that’s best for you. Decide what type of Estate Plan you need.
4. Choose who you would like to be guardian of your children/pets/self. If you have children or pets, or if you care for another loved one who cannot care for themselves, you want to choose a guardian. You can also name the person you would want to make medical and/or financial decisions on your behalf should you ever become unable to do so for yourself.
5. Determine and establish the necessary directives. There are several directives you should include in your Estate Plan, including but not limited to:
• Durable Power of Attorney
• Medical care directive
• Limited Power of Attorney – LPOAs are less commonly used (Durable POAs are more frequently the norm), though an LPOA can be appropriate in some instances.
6. Name your Beneficiaries. Some documents and accounts will have Beneficiaries already designated. These could include retirement plans and life insurance policies, to name a few. But there are other assets you should note in your Will or Trust if you’d like to leave them to a specific person. If there is an opportunity, you should name contingent Beneficiaries. Keep in mind that Beneficiary designations will only go into effect after you pass, so if you become incapacitated and unable to make decisions, you need to have prepared for more than simply naming beneficiaries.
7. Find a trusted partner. Explore your options for creating your Estate Plan. This can be face-to-face with an attorney or you may choose to use another service provider. You have options, but some are going to be much more expensive than others. If you don’t have an overly-complicated estate, working with a partner like Trust & Will could be the perfect solution to starting on the path of Estate Planning.
8. Create your plan. If you’re using an online program to create your Estate Plan, be sure to go through all the steps and finalize everything.
9. Sign and notarize your Estate Plan. Don’t forget to check how many witnesses your state requires.
10. Notify your Executor. It’s a good idea to let the person you chose to be your Executor knows of your intentions.
11. Store your Estate Planning documents. Put your Estate Plan in a safe place where your loved ones can easily find it. A fireproof safe is a good idea.
12. Update as needed over time. There isn’t a hard rule about when you should update your Estate Plan, but a good rule of thumb is try to update it whenever you have a major life event (birth of a child, death of someone important to your plan, marriage, divorce, etc.). And if you find you haven’t had any life events in recent years, try to review and update as needed every 3 – 5 years.

Common Estate Planning Mistakes to Avoid

Take caution when developing your Estate Plan. There are many mistakes that could result in delays, inaccuracies or other misunderstandings. Some of the common mistakes people make along the way include:
• Not having an official plan
• Not updating a plan over time (at major lifetime events)
• Not making arrangements for if they become incapacitated (disability or long-term care)
• Improper ownership of assets (how easy will it be to pass assets on)
• Not including charitable gifts
• Not appointing a guardian for children or others who would need their care
• Underestimating the implication of taxes
• Not having liquidity of assets
• Not making gifts during their lifetime to reduce the value of the estate after passing (tax advantages)
• Putting their child’s name on the deed to property (potentially huge tax implications)

How Much Does an Estate Plan Cost?

The cost of creating an Estate Plan can widely vary, depending on a number of factors. If you go the traditional route and work face-to-face with an attorney, your cost will be much higher. Newer methods of Estate Planning include innovative and creative platforms like Trust & Will, where you can get a legal Estate Plan at a fraction of the cost. In some cases, you do not need an attorney to create your Estate Plan. If you have a very complicated estate, you may opt to go the traditional face-to-face route. But many people have simple, straight-forward needs. They may find a service like Trust & Will is ideal for their Estate Planning needs. It can save time and money while still offering a superior product that touches on all the important things you want to take care of with your Estate Plan. Though there are many parts to a complete Estate Plan, tackling them one at a time is the best way to draft a plan that’s conclusive, comprehensive, thorough and that protects everyone in your life you love.

Estate Planning Law

When you need help with probate law, estate planning or asset protection in Utah, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.