When an heir inherits property at the owner's passing, a step-up in basis comes into play. Because of the step-up in basis, there are tax advantages for heirs. But do heirs have a choice, or can they elect out of a step-up in basis? Let's find out.
What is a Step-Up In Basis?
A step-up in basis occurs upon the death of the asset owner. Assets are then passed on to heirs according to the owner's estate plan. Instead of inheriting assets at the original purchase price, heirs will inherit at the current fair market value. This is called a step-up in basis since the value of inherited assets steps up to a higher market value from their lower original basis.
A step-up in basis can be a big tax advantage for heirs when the value of inherited assets has appreciated. If heirs had to inherit at the original basis on assets that had greatly appreciated, they’d experience a large tax bill at the time of inheritance. The step-up in basis avoids this by marking the basis to the current market value.
There's also a step-down in basis, which is the opposite of a step-up in basis. A step-down in basis occurs when the market value of inherited assets at the time of death is less than the original basis. Basically, this is an unrealized loss on the property compared to the original basis. But since the property is marked to market at the time of death, no loss will be realized if the property is sold.
An example of a step-down in basis is the owner purchasing stock worth $50,000. At the time of death, it is worth $30,000. Heirs will inherit the stock at $30,000. If the stock appreciates to $40,000 and the heirs decide to sell it, they will realize a $10,000 capital gain and owe taxes.
Is Step-Up In Basis Mandatory?
Heirs have no choice when it comes to a step-up or down in basis. Both are required under current tax laws. There is no option to elect out of inheriting property at the fair market value.
The good news for heirs is that they will not immediately owe taxes on inherited property. Of course, that can change if the property appreciates over time and the heirs decide to sell. Realized capital gains will be owed on any appreciation upon selling the property.
While a step-up in basis sounds straightforward, tax scenarios and the process of inheriting property can get complicated. Working with a tax specialist can help to ensure this process goes smoothly for all involved.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Hypothetical examples shown are for illustrative purposes only.
