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How to Manage Your Basis “Step Up”

Posted by James Lloyd | Sep 14, 2020 | 0 Comments

If you or someone you know has received an inheritance, it is important for you to understand how to manage your basis “step up.” A “step up” in basis is the adjustment of the value of an appreciated asset - for tax purposes - upon inheritance.

IRS Taxes

An executor who has to file a federal estate tax return must also file Form 8971 with the IRS. The purpose of Form 8971 is to report the final value of the specific property received by a beneficiary, the recipient of that property, and other information. An executor must also provide a Schedule A to each beneficiary who has acquired - or will acquire - property from the decedent and the final value of that property. Although this form is only required when an estate tax return is needed, the basis step-up occurs for everyone receiving an inheritance.

Step Up Basis Explained

Simply put, when an asset is passed on to a beneficiary, the value of that asset at the time it is inherited is generally higher than it was when the original owner acquired the asset. Accordingly, the asset receives a “step up” in basis to equal the value of the asset on the decedent's date of death. This has the effect of minimizing the beneficiary's capital gains tax.

A step-up in basis reflects the changed value of an inherited asset. For example, an investor who purchased shares at $20 and who then leaves these shares to an heir upon her death, when the shares are $45 means the shares receive a step-up in basis, making the cost basis for the shares the current market price (at the time of death) of $45. Any capital gains tax paid in the future by the beneficiary will be based on the $45 cost basis, not on the original purchase price of $20.

 

The step-up in basis rule changes tax liability for inherited assets in comparison to other assets. For example, let's say that Roger bought a home in 1997 for $300,000. When he passes, his son Robert inherits the loft after Rogers's death with a market value of $500,000. When Robert sells the home, his tax basis will be $500,000. He will pay taxes on the difference between the selling price and his stepped-up basis of $500,000. If Robert's cost basis were the original $200,000 (the cost that Roger originally paid), Robert would have to pay much more in capital gains taxes when selling the property.

As an Executor or beneficiary, it is important to be diligent about keeping good records and obtaining paperwork from the courts, trustees, and other parties involved.  This will help ensure you are using the step up basis correctly and minimizing the risk of IRS audits.

If you have questions about an inheritance you have received - or expect to receive - contact us to learn about your options.

About the Author

James Lloyd

Jim Lloyd is a husband, father and attorney. A graduate of Tulane University School of Law, Jim brings over 25 years of legal experience to help clients make strategic estate planning choices and to make buying or selling a house easier.

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