While creating your estate plan, it is crucial to consider not only asset distribution but also the potential impact of taxes on your estate and the inheritances you intend to leave behind. Particularly, understanding how capital gains taxes might erode the value of assets passed down to beneficiaries is essential. Fortunately, there are estate planning strategies available to mitigate the impact of taxes on inheritances. To help you better understand, the Los Angeles attorneys at Schomer Estate & Wealth Advisors shed light on how a basis step-up can be advantageous within your estate plan.
Capital Gains Taxes and Property Basis
When assessing taxes on assets, the term “basis” denotes the value used to calculate tax obligations. Specifically, it comes into play when determining capital gains taxes, which are levied when an asset is sold for a profit compared to its acquisition cost. For example, if you bought 1000 shares of stock a decade ago at $20 per share ($20,000 in total) and today they are valued at $50 per share, selling them would yield you $50,000 representing a $30,000 gain. Capital gains taxes apply to this realized gain because the Internal Revenue Service (IRS) considers that gain to be income. The rate at which capital gains are taxed can vary up to 20 percent as of 2024.
Understanding Basis Step-Up
The basis of property holds significant importance in estate planning as capital gains taxes can substantially reduce the value of an inherited gift. Consider owning a family home purchased 30 years ago for $40,000 that is now valued at $500,000. If you make a lifetime gift of this home to your daughter and she sells it, she will face a $460,000 gain using your original basis, resulting in substantial capital gains taxes. This is where the benefit of a stepped-up basis becomes apparent.
In estate planning, a “step-up” in basis permits a beneficiary to use the asset’s value at the time of inheritance rather than the being forced to use the donor’s original basis for the purpose of calculating any capital gains taxes due upon the sale of the asset. In the example above, your daughter would inherit the home with a basis of $500,000 instead of having to use your basis of $40,000. If she sells it later, her basis would be $500,000, drastically reducing the capital gains taxes owed compared to using the original $40,000 basis.
Stepped-Up Basis and Jointly Owned Assets
Calculating tax implications for jointly owned assets adds complexity. In most states, jointly owned assets are considered “separate property” for tax purposes. Upon inheritance, only 50 percent of the asset’s value is included in the decedent’s estate, eligible for a basis step-up. The surviving spouse retains the original basis for their half.
For instance, if you co-own a home with your spouse, and your spouse passes away, her half of the original basis receives a step-up. Your basis would then comprise her stepped-up basis plus your original basis. This calculation can significantly impact capital gains taxes upon the sale of the property. In our example of the home purchased for $40,000, imagine that you purchased it jointly with a spouse and upon your death your ownership interest is gifted to your spouse. Your half of the home would receive a step-up in basis to the current value of $500,000 (meaning $250,000) while your spouse’s half would retain the original basis of $20,000 (half of $40,000). The total basis of the home would now be $270,000 (your half of $250,000 plus your spouse’s $20,000).
Do You Need Help Incorporating a Basis Step-Up in Your Estate Plan?
For more information, please join us for an upcoming FREE seminar. If you have questions about how to incorporate a step-up in basis into your estate plan, contact the experienced Los Angeles estate planning attorneys at Schomer Estate & Wealth Advisors by calling (310) 337-7696 to schedule an appointment.
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