Those who are estate planning and have recently inherited assets may not be sure of the “cost” (or “basis”) for tax purposes—here’s a quick guide to get you up to speed.
Current fair market value basis rules
Current fair market (or “step-up and step-down”) value basis rules hold that an heir receives a basis in inherited property that is equal to its date-of-death value. This means that if an heir’s grandmother bought stock in 1950 for $200 and that stock is worth $2 million at the time of her death, the basis is stepped up to $2 million in the hands of the heir. All of this gain is also exempt from federal income tax.
These rules apply both to any inherited property that’s includible in the deceased’s gross estate and to property that’s inherited from non-U.S. citizens who aren’t subject to U.S. estate tax. Whether or not a federal estate tax return is filed doesn’t matter for these purposes.
The value basis rules apply to the inherited portion of property that is jointly owned by the inheriting taxpayer and the deceased, but don’t apply to the portion of jointly held property that was owned by the inheriting taxpayer before they received their inheritance. These rules are also not applicable to reinvestments of estate assets by fiduciaries.
Making the most of the current rules
Understanding the current fair market value basis rules is crucial if you’re looking to avoid paying more tax than you’re legally obligated to.
For example, the “step-up” in basis (from $200 to $2 million) would be lost if the grandmother mentioned earlier decided to make a gift of the stock during her lifetime instead of passing it on as an inheritance when she died. This is because property that has gone up in value and is acquired by gift falls under the “carryover” basis rules (rather than “step-up” rules)—meaning that whoever recieves the gift will take same basis the donor had in it (in this example, $200), plus a portion of any gift tax paid on the gift by the donor.
If someone dies owning property that’s declined in value, a “step-down” occurs. In the case of a “step-down,” the basis is lowered to the value at the date of death. As such, you should make a plan to avoid this loss of basis—and simply giving the property away before your death won’t help you to avoid the step-down.
When a gift is made of property that has gone down in value, the person receiving the gift is required to take the date-of-gift value as their basis for the purposes of determining their loss on a later sale. Because of this, the owners of property that has declined in value should plan to sell it before death so that they can enjoy the tax benefits from the loss.
Be prepared for possible changes
It’s worth noting that President Biden has proposed a change to the rules for stepping-up basis. Under this proposed change, inheritors will no longer be able to step-up the basis for any gains in value over $1 million. The change would include exemptions for farms and family-owned businesses. However, this proposal would have to be approved by Congress before it can be enacted.
Although these are the basic rules, there are other limits and rules that may apply. For example, a deceased person’s executor might be able to make an alternate valuation election in some cases. If you’re estate planning or have received an inheritance, contact us—we can help you stay up to date on any tax law changes.