Step Up in Basis – Definition

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Step-up in Basis Definition

The revaluation of an increase in value of an asset when it is inherited for tax-based purposes is known as step- in basis. It is the greater market value of the asset that is used for tax-based purposes during inheritance. The value of money or property increases in comparison to what it was when the asset passes on to an heir. There is a step-up in basis in the asset that helps the beneficiary in paying less tax on capital gains.

A Little More on What is Set-up in Basis

A step-up in basis brings the transparency in the fluctuation or change in the value of an asset which one receives upon inheritance. For example: an investor buys shares at $2, and his or her heir gets these shares when their value is $15. It means the shares face a step-up in basis that makes the cost basis for the shares and the current market price of these shares reaches up to $15. It is clear that in future, any changes regarding capital gains, will take place according to $15 instead of the original price which one pays to buy the shares i.e. $2.

The step- up in basis rule brings a change in the tax liability for the assets received upon inheritance as compared to other assets. This means that there is an increase in the tax to be paid according to the inherited asset which depends on the step-up in basis rule which does not apply on other assets. For instance, Sarah purchased a loft worth $300,000 in the year 2000. The same loft valued $500,000 upon inheritance by Paul). The tax basis of loft was $500,000 when Paul sold it. He incurred tax based on the sale price and the stepped-up basis worth $500,000. In case, the cost-basis was $200,000, he would have to incur more taxes upon the sale of loft.

Step-up in basis for community property states

People residing in community property provinces like Wisconsin can get benefitted from this double step-up in basis rule. For instance, Allan & Jo invested in a home and bought it for $355,000 in the year 1977. They deeded the residential property to the revocable living trust. After Allan’s death in 2006, the house property remained in the trust, and Jo got the step-up in basis with the home’s market price of $500,000. Further, after Jo’s death in 2015, the home was inherited by their daughter named Stephanie. The market value of home that was $700,000 worked as a cost basis for Stephanie. She was inheriting a home that was a part of double step-up in basis and the double step-up policy helped her in reducing her tax obligations.

Step-up in basis as a tax loophole

The step-up in basis helps in saving taxes indeed, however, this policy has been a subject of criticism for wealthy individuals. They exploit the policy of step-up in basis to their benefit so as to reduce tax obligations. For instance, they can avoid taxes on capital gains earned on investments by securing their holdings in a trust fund for their legal heirs.

Generally, a millionaire may prefer investing in property and stocks that can appreciate in value, and offer them a stable rate of return throughout their life. After their death, their legal representatives would have advantage over the investment as they will be stepped up on cost basis, and not the actual costs, hence allowing them to ignore huge amounts of taxes. The famous example would be of the Walton family’s case that owns Walmart and is believed to have invested the majority of their holdings in real estate so as to evade taxes.

Many economists have suggested abolishing step-up in basis and bringing lesser capital gains taxes in its place. The supporters of the policy argue that it is easy to ascertain the asset’s value no matter how old it is.

Example of a step-up in basis

If an individual inherits mutual funds, he or she will get a step-up in basis for the value of the funds invested. So, upon the investor’s death, the share’s price becomes the cost basis for the legal representative. Once the representative has offered valid documents to the mutual fund organization for authentication purposes, he or she can receive the shares to the given account or the company can transfer the proceeds from stock to the heir’s account upon sale.

References for “Step-Up In Basis › Managing Wealth › High Net Worth Strategy › Personal Finance › Estate Planning › Glossary

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