One of the most common questions for people planning their estates or inheriting assets is: What is the “cost” (or “basis”) a person gets in property that is inherited from someone else? This vital area is often overlooked when families start planning for the future.
According to the fair market value basis rules (otherwise known as the “step-up” and “step-down” rules), an heir can receive a basis in inherited assets equal to their date-of-death value. For example, if your uncle bought shares in an oil stock in 1942 for $500 and the stock was worth $5 million at the time of his death, the basis would be stepped up to $5 million for your uncle’s heirs, which means that the gain on the stock would escape income taxation forever.
Fair market value basis rules apply to any inherited property that can be included in the gross estate of the deceased individual, whether or not a federal estate tax return was filed. The rules apply even to property inherited from foreign individuals not subject to U.S. estate tax.
Fair market value basis rules also apply to the inherited portion of the property jointly owned by the inheriting taxpayer and the deceased, but not to the portion of the jointly held property that the inheriting taxpayer owned prior to their inheritance. They don’t apply to reinvestments of estate assets on the part of fiduciaries.
Lifetime gifting
It’s important to understand the fair market value basis rules so that you can avoid paying more tax than you’re legally required to.
For example, in the previous scenario, if your uncle instead decided to make a gift of the stock during his lifetime (rather than passing it down to his heirs when he died), the “step-up” in basis (from $500 to $5 million) would be lost.
Property acquired as a gift that has increased in value is subject to the “carryover” basis rules. This means that the person who received the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift.
If someone dies owning property that has declined in value, a “step-down” occurs. In this case, the basis is lowered to the date-of-death value. Sound financial planning can help avoid this loss of basis, and it’s important to note that giving away the property before death won’t preserve the basis.
Why is that? Because when a property that has gone down in value is given as a gift, the person who receives the gift must use the date of gift value as the basis for determining their loss on a later sale. An excellent strategy for handling a property that has declined in value is for the owner to sell it before death so they may enjoy the tax benefits of the loss.
Have questions? Smolin can help
We’ve covered the basic rules here, but other rules and limits may apply. For example, in certain cases, a deceased person’s executor may be able to make an alternate valuation election, and gifts made just before a person died may be included in the gross estate for tax purposes.
If you’re wondering how you can benefit from a “stepped-up basis” or need guidance with planning your estate, contact the knowledgeable professionals at Smolin. We’re ready to guide you through complicated tax laws to ensure you miss out on possible savings for your estate or inheritance.