Step Up in Basis – Why is it important?

House and increasing stacks of coins

The IRS allows a major benefit on the death of individual called a “step-up” in basis, which can save beneficiaries of an asset significant amounts of income tax on capital gains.

To understand the “step up” in basis rules, it’s important to understand how the income tax on capital gains works.  Generally, sales of assets that have appreciated during an owner’s life are subject to a capital gains tax.  The price that an asset was purchased at is the “basis” of the asset, and on sale, capital gains tax is computed on the amount of the sales price of the asset which is over the asset’s basis.

As you can imagine, as we hold an asset for a long period, the sales price of an asset can be far greater than the basis of the asset, and significant amounts of income tax can be owed on a sale if the asset has appreciated substantially.

However, on the death of the owner of an appreciated asset, the “step up” in basis rule allows the basis of an appreciated asset inherited by a beneficiary to be moved up to fair market value.

To illustrate, imagine Robert had purchased a share of stock at $20 per share, and at Robert’s death, the fair market value of that share of stock was $200.  If Robert left the share of stock to his daughter Claudia in his Will, Claudia would get a “step-up” in basis to $200 for the share of stock.  If Claudia sold the stock the next day for $200, she would owe no capital gains tax.

Sometimes, it is good planning to hold an appreciated asset until death to give beneficiaries a step-up in basis to fair market value as of the owner’s date of death. 

Be sure to mention to your advisor that you have highly appreciated assets, and proper planning can save your beneficiaries significant amounts of capital gains tax.

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