A Step Up In Basis

It is common in estate planning and business succession planning – amongst other areas – to hear the phrase “a step up in basis.” A step up in basis means that the basis (i.e., the value) of the asset is stepped up to the value of the asset as of the date of death. Therefore, the tax is based on the fair market value as of the date of death rather than at the date of purchase. This article will provide a general overview through hypotheticals. The information provided is not tax advice. Please consult with your tax advisor for tax advice regarding your situation.

Hypothetical: Mary passes away. She has two adult daughters. Mary purchased investments during her lifetime with the beneficiary designation equally to her two daughters. At the time she purchased the investments, they were worth $20,000. At the time of her death, those investments were worth $100,000.00.

Analysis: Upon Mary’s death those assets get a step up in basis to the fair market value at the time of her death. Thus, the daughters will have no capital gains, under current law, because the basis of those assets resets at the time of Mary’s death to $100,000.00.

Hypothetical: Bob and Margaret own their homestead jointly. It is worth $300,000.00. They purchased it decades ago for $40,000.00. When Bob died the home transferred by operation of law to Margaret because she was a joint owner. Margaret has two children who suggested that Margaret quit claim deed the home to them and complete a gift tax return thereby avoiding probate of the home at the time of Margaret’s death. Margaret agrees. Subsequently, Margaret dies and the children sell the home.

Analysis: The children have to pay capital gains tax on the sale of the home with Margaret’s basis.

If Margaret would have gifted the home in her estate planning documents to her daughters, there would have been no capital gains when the children sold the home after Margaret’s death. This is because Margaret’s children would have received a full step up in basis.

Hypothetical: Robert owns Robert’s Fine Driving, LLC. His only daughter, Maddie, works for the LLC and is not an owner. However, she is a key employee and has worked for her father’s company for 20 years. Robert gets very sick. He decides he needs to complete his planning immediately. He does this through his estate planning, which gives to his daughter all of his assets, including the LLC.

Analysis: Maddie gets a step up in basis, including the ownership of the LLC. Therefore, if Maddie had purchased her interest from her father 20 years ago, her basis would have been set at that purchase price. However, since she inherited it 20 years later and the business is worth substantially more she received a basis reset at the time of her father’s death. If she was to sell the business today, she would not have any capital gains as a result.

Spangler and de Stefano, PLLP assists business owners and individuals with their estate planning and business succession planning.

The material contained herein is for informational purposes only, and is not intended to create or constitute an attorney-client relationship between Spangler and de Stefano, PLLP and the reader. The information contained herein is not offered as legal advice and should not be construed as legal advice.