STEP UP COST BASIS AND INHERITING REAL ESTATE
The step up cost basis is a way of adjusting capital gains tax. This means that for the purpose of capital gains tax, the IRS re-sets the cost basis of the property to its value when the asset is inherited. The IRS “steps up” the cost basis of an inherited property to current market value at time of death of the decedent.
SPECIAL CATEGORY OF TAXES
Capital gains is a special, generally lower, category of taxes imposed at the time an asset is sold. Capital Gains tax is owed on the increase in value from the date it was purchased. In the case of an inherited a property, when the heir sells the asset, they pay taxes on profits calculated from the day they inherited it.
Example:
Joe’s Dad leaves his home to his son in his will. Joe’s Dad bought the property 10 years ago for $100,000. At the time of his Dad’s death, market value of the home is $250,000. A $150,000 gain in value since his Dad purchased. With the step up basis, Joe does not pay tax on the gain during the time his Dad owned the property. Joe will owe capital gains tax on the difference, between $250,000 and the sale price, if greater than $250,000. when he sells the property.
IMPORTANT BENEFIT FOR FAMILIES
The step up cost basis is an important benefit for families, it allows parents to pass a property on to their kids without the kids having to sell the asset just to pay the taxes. The new basis of the property becomes the fair market value at the time of the decedent’s death. This avoids recognizing the gain between the decedent’s cost and what it is worth when it is inherited.
Much of the supposed gains subject to capital gains taxes, particularly those passed down from one generation to the next, are driven by inflation, rather than appreciation of the underlying asset. The step-up in basis is a tool which can shield heirs from paying taxes on inflation.
FORMAL APPRAISAL
A formal appraisal is the most reliable and defensible estimate of fair market value at the time of the decedent’s death to establish the step up cost basis, but there will be a charge for the appraisal – it can be several hundred dollars. An alternative would be broker’s opinion of value in writing. It may be reasonable to get three opinions to see if they are similar. They should rely on comparable sales to justify their position. Either method is acceptable to IRS.
ELIMINATING THE STEP UP COST BASIS?
There is discussion from the current President about the possibility of eliminating the step up cost basis. Some people consider it to be a tax loophole for the ultra-rich, but it heavily impact’s ordinary people who inherit property if they have to sell it to pay the capital gains tax.
An example would be a family farm, the heirs may not be able to afford to pay the capital gains tax due at time of transfer and they could be forced to sell the property or borrow the money to pay the tax, if that was possible.
We could see an increase in people trying to transfer assets prior to death
PROFESSIONAL ADVICE
Federal estate tax is paid from the deceased’s remaining estate, not by the heir. If the decedent’s estate is approaching the limit before estate taxes are due, currently $11.7 million, professional tax advice should be considered – there could be additional provisions in play. More information on this can be found on IRS.gov.