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Step-up in basis and its role in estate planning

by Legacy Plan
Novemebr 10, 2023

The concept of step-up in basis plays a crucial role in estate planning, particularly when it comes to minimizing capital gains taxes on inherited assets. Understanding how step-up in basis works is essential for beneficiaries and individuals seeking to transfer assets efficiently.

Step-up in basis refers to the adjustment of the cost basis of an asset to its fair market value at the time of inheritance. Cost basis is usually determined by the purchase price of an asset.

However, when an individual inherits property or investments, the cost basis is "stepped up" to the fair market value at the date of death, or potentially an alternate valuation date if applicable. For example, let's say John purchased a lake house 30 years ago for $200,000.

Over time, due to appreciation and market conditions, the lake house is now valued at $800,000 upon John's passing. If John bequeaths this property to his daughter Sarah upon his death and she decides to sell it immediately afterward for $800,000 (the same market value), Sarah will not owe any capital gains taxes on this transaction.

This is because her step-up in basis adjusts the cost basis from John's original purchase price of $200,000 to its current fair market value of $800,000. Step-up in basis applies not only to real estate but also other capital assets like stocks.

It allows beneficiaries to avoid paying taxes on appreciated assets received through inheritance. By resetting the cost basis to reflect current market values at the time of inheritance rather than their original purchase price, beneficiaries can potentially save significant amounts on future capital gains taxes when they decide to sell these assets.

Understanding how step-up in basis works is vital for effective estate planning as it presents opportunities for tax minimization and asset protection strategies while transferring wealth across generations seamlessly.

How does step-up in basis apply to stocks and bonds?

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When considering the application of step-up in basis, it is essential to understand how it applies not only to real property but also to stocks and bonds. The step-up in basis provision can have significant implications for beneficiaries who inherit stocks and bonds.

Let's delve into the intricacies of this particular aspect of step-up in basis. In the case of stocks and bonds, the concept of step-up in basis operates similarly to that of real property.

When an individual passes away and leaves behind a portfolio of stocks and bonds, their beneficiaries will receive these assets at their fair market value on the date of death. This means that if the beneficiary chooses to sell any of these assets, they would only be subject to capital gains tax on any appreciation that occurs after inheriting them.

For instance, consider an individual who purchased shares in a company decades ago for $10 per share. Over time, the value of these shares has appreciated significantly, reaching $100 per share at the time of their passing.

If their beneficiary decides to sell these inherited shares shortly after inheriting them, they would only be liable for capital gains tax on any appreciation above $100 per share. It is worth noting that while step-up in basis does apply to most inherited stocks and bonds, there are exceptions.

For instance, if an individual inherits certain retirement accounts like IRAs or 401(k)s, they do not benefit from a step-up in basis. In such cases, distributions from these accounts are subject to ordinary income tax rates upon withdrawal.

When it comes to stocks and bonds as inherited property, beneficiaries can take advantage of the step-up in basis provision by inheriting these assets at their fair market value on the date of death. This allows them to minimize potential capital gains taxes when selling appreciated assets inherited from a deceased loved one.

Step-up in basis for joint tenants

two men on a park bench

Joint tenancy with right of survivorship is a common form of ownership where two or more individuals hold property together, and when one joint tenant passes away, the surviving joint tenant automatically inherits the deceased tenant's share. This type of ownership structure can have significant implications for step-up in basis when it comes to estate planning. When a joint tenant dies, the surviving joint tenant receives a step-up in basis on their inherited portion of the property.

For example, let's say John and his brother Jim jointly own a cottage they purchased many years ago for $200,000. Over time, the cottage appreciates in value and is worth $500,000 at John's death.

When Jim inherits John's share as a surviving joint tenant, his new basis will be $350,000 (half of the fair market value, which is $250,000, plus the basis of John’s share, which is $100,000). If Jim decides to sell the property later on for $600,000, his taxable gain would only be $250,000 (sale price minus new basis), resulting in reduced capital gains taxes compared to if he had retained his original basis.

It's worth noting that step-up in basis for joint tenants applies not only to real estate but also to other assets held jointly such as brokerage accounts. However, it is crucial to understand that there are specific rules and limitations regarding each asset type and how they are treated under step-up provisions.

Consulting with an experienced estate planning attorney or financial professional is highly recommended to navigate these complexities and maximize potential tax benefits while ensuring compliance with relevant regulations. Joint tenants stand to benefit from step-up in basis provisions when it comes to estate planning.

This favorable tax treatment allows surviving joint tenants to inherit their co-owner's share of property at its fair market value, minimizing potential capital gains taxes upon future sale or transfer. While joint tenancy can offer beneficial asset protection and simplify the transfer of property, it is essential to consider the specific rules and regulations surrounding step-up in basis for various asset types to make informed decisions and optimize tax planning strategies.

Trusts and step-up in basis considerations

When it comes to estate planning, many individuals choose to establish trusts as a means of managing and distributing their assets. Trusts provide a variety of benefits, including asset protection, privacy and control over how assets are distributed to beneficiaries.

Booklet opening animation of our free requestable booklet 'What is Joint Tenancy'

However, when considering trusts in relation to step-up in basis, there are several important factors to take into account. One crucial consideration is the type of trust involved.

Revocable living trusts operate differently than irrevocable trusts with regard to step-up in basis. With a revocable living trust, the grantor retains control over the assets during their lifetime and can modify or revoke the trust at any time.

In this case, step-up in basis does not apply until after the grantor's death when the assets pass on to beneficiaries. On the other hand, irrevocable trusts typically involve transferring ownership of assets into the trust permanently.

Consequently, if appreciated assets are held within an irrevocable trust and transferred at death, they may be eligible, but usually are not, for a step-up in basis. Another factor to consider is how distributions from a trust impact step-up in basis.

Trust distributions made during the grantor's lifetime do not generally result in a step-up in basis for beneficiaries upon the grantor's death. This means that if appreciated assets are distributed from a trust before death — for instance as income or gifts — beneficiaries may inherit these assets with a carryover basis rather than receiving a stepped-up cost basis.

As a result, they could potentially face higher capital gains taxes upon selling those inherited assets. Additionally, it is essential to assess whether using trusts for specific types of property could affect step-up in basis eligibility.

While real property such as homes or cottages can benefit from a step-up in basis because they appreciate over time and may have significant unrealized gains upon transfer via inheritance, other assets like retirement accounts – for example, 401(k), IRA or brokerage accounts – may have different rules. For instance, retirement accounts are subject to their own tax regulations, and the step-up in basis concept does not apply to them.

Understanding these distinctions is crucial when structuring a trust to ensure that the most advantageous tax outcomes are achieved for beneficiaries. Trusts play a significant role in estate planning, providing individuals with various benefits such as asset protection and control over distribution.

However, when considering step-up in basis within the context of trusts, it is important to consider factors such as the type of trust being utilized and how distributions from the trust can impact eligibility for stepped-up cost basis. Moreover, understanding how different types of assets are treated under step-up in basis rules can help individuals make informed decisions about incorporating trusts into their estate plans while minimizing potential tax implications for beneficiaries upon inheritance.

How do I create an estate plan?

There are numerous options and scenarios to consider when developing an estate plan that protects your legacy and achieves your objectives, and important decisions should be made with the advice of qualified lawyers and financial experts. Membership with Legacy Assurance Plan provides members with valuable resources and guidance to develop comprehensive estate plans that take life's contingencies into consideration and leave a positive impact for generations to come. Legacy Assurance Plan members also receive peace of mind that a team of trusted, experienced professionals will assist them in developing legal, financial and tax strategies that will meet their needs today and for years to come through periodic reviews.

This article is published by Legacy Assurance Plan and is intended for general informational purposes only. Some information may not apply to your situation. It does not, nor is it intended, to constitute legal advice. You should consult with an attorney regarding any specific questions about probate, living probate or other estate planning matters. Legacy Assurance Plan is an estate planning services company and is not a lawyer or law firm and is not engaged in the practice of law. For more information about this and other estate planning matters visit our website at

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