I know, tax stuff is boring, unless you are having to pay taxes you shouldn’t. So, today, I’m going to address a great tax benefit of property passing through estates, and why you don’t want to lose that benefit. We are going to talk about the “step up basis” rules.
A taxpayer’s basis is usually their purchase price of an asset. When sold for a gain, the difference between the sales price and basis equals the capital gain subject to capital gain tax rates. Although the rates charged on capital gains are not this simple (we are talking the Tax Code here), for many that rate is 20% and we will use that for our discussion. Accordingly, taxpayers who hold assets for an extended duration, commonly individual stocks and real estate, see those assets substantially increase in value building up an untaxed capital gain. Selling those assets triggers the taxation of the capital gain, e.g. the gain is “realized.”
One long-time feature of our tax code is that the beneficiaries of an estate receive the asset with a “step-up” basis. The spouse, children, or other beneficiaries of a decedent’s estate do not pay a capital gain based on the price the decedent purchased the asset, but a value at the date of the decedent’s death. Because of inflation and other reasons, this is usually an increased value so the basis “steps up.” Unlike estate taxes, which apply to only those above the exemption amount, the capital gain tax applies to all taxpayers and the step-up basis rules benefit beneficiaries of even modest estates.
Here is a simple illustration: Ms. A purchases 100 shares of Apple for $100 a share (a $10,000 investment). She holds them for many years and now they are worth $1,000 a share. If she sold them, she would pay a capital gain of $900 a share. If she passes, her beneficiaries receive a basis of $1,000 a share (assuming that is the value on date of death), and if they immediately sell the stock, they pay no capital gains tax. The savings to the heirs is $18,000 ($90,000 gain taxed at the assumed 20% rate).
So what is the most common thing done that destroys this great tax loophole? Someone like Ms. A, in their generosity, gifts away property prior to death. The recipient of a gift has ZERO basis. Now, the entire sales price of the asset is taxable! Using the illustration above, if Ms. A sells she has a $90,000 gain. If her heirs sell they have zero gain. But if she gifts the Apple stock and the recipient sells, they have a $100,000 gain. That turns a tax benefit into a tax loss! Yet, it happens all the time because people don’t bother to speak to a lawyer.
Be generous with your wealth, but be smart. Uncle Sam does not need your generosity.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, specific tax, legal or accounting advice. We can only give specific advice upon consulting directly with you and reviewing your exact situation.
