How to Manage Your Basis “Step Up”

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.

Step Up Basis Explained

Basis is essentially the purchase price of a piece of property. For example, if you purchase a stock for $100, that is your basis in the stock. If the value has increased at the time you sell the property, you generally must pay capital gains tax on the increase in value. So, for our $100 stock, if it increases in value to $150 and you sell it, you will have a gain of $50 and owe capital gains tax on that growth. For certain types of assets, there are some more complicating factors, but this is essentially how basis and capital gains taxes work.

When you leave property to a beneficiary at your death, they will generally receive what is called a “step up” in basis. That means when calculating the capital gains tax that may be owed, the basis is the value on your date of death. Going back to our example above, for the $100 stock, if it has grown to $150 at your death and is passed to a beneficiary, the beneficiary’s basis is $150 and there is no capital gains tax owed. Again, there can be more complicating factors and certain types of assets do not receive a step up, but this is generally how the step up in basis works.

When planning your estate, considering basis and planning for capital gains taxes is more important for most people nowadays than planning for estate taxes. It can also be very important to consider basis and taxes when dividing your estate between children or other beneficiaries to make sure you are planning for the net (post-tax) amounts received by beneficiaries and not just the gross (pre-tax) gifts.

Basis Reporting

An executor or trustee who files 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.

Keeping good records and obtaining paperwork from the courts, trustees, and other parties involved will help ensure you are using the basis step up 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.