Tax basis is the amount of the taxpayer’s investment in a particular asset. The basis is used to calculate depreciation and amortization for tax purposes.
Step-up in basis is used to calculate taxes owed on inheritances. This is done by readjusting the value of an appreciated asset. When someone inherits property either as a beneficiary of a will or trust, and then subsequently sells the asset, capital gains taxes may be owed. The value at the time of the transfer is likely higher than the value when the grantor originally acquired the property. The step-up in basis provision kicks in and readjusts the tax basis of that asset. It allows the basis to “step-up” or increase to the amount at the time of death rather than the amount invested when the asset was originally acquired by the deceased.
For example, a grandfather purchases his vacation cottage for $75,000 in 1980 and leaves it to his grandson in 2021. The beachfront cottage is now worth $875,000. The step-up in basis makes the readjusted basis the value at the time of death ($875,000) rather than the $75,000 original purchase price. In the future, when grandson sells the cottage, he owes capital gains on any appreciation over the $875,000 value. That is a huge difference in owing capital gains on anything over $75,000.
This tax provision has long been criticized as a tax loophole allowing the wealthy to avoid taxes. Many tax avoidance strategies are built around these step-up in basis allowances. Stocks and real estate can be placed into trusts for future heirs allowing those heirs to inherit the assets with a step-up in basis and minimize the taxes owed on the value of property.
With the many changing tax laws on the horizon, it will be imperative to watch for any legislation that eliminates the step-up in basis provisions. Eliminating it will impact anyone inheriting any property – even those who are not especially wealthy.
For more information on estate planning and estate administration, contact the knowledgeable attorneys at Stouffer Legal in the Greater Baltimore area. Understanding how tax regulations and changes impact overall estate planning is essential in ensuring your overall planning goals are reached. You can schedule an appointment by calling us at (443) 470-3599 or emailing us at firstname.lastname@example.org.