What is a Step-Up in Basis?
We refer to the purchase price of an asset as “basis.” Capital gains tax is payable on the difference between an asset’s purchase price and its fair market value at the time of sale. Depending on your income, the current capital gains tax rate is 0%, 15% or 20%. A “step up in basis” refers to an adjustment in value of an inherited asset, such as stocks, bonds or real estate, upon the passing of the original purchaser of the asset.
A step up in basis adjusts the value of an asset from its original purchase price to its fair market value (the price at which the asset would be sold) at the time of the original purchaser’s death. This typically reduces capital gains tax on the asset owed by the person inheriting the asset who goes to sell it later on.
For example, Abe purchased a home for $100,000.00. Ten years later, Abe passes away, leaving the home to Abe’s son, Brad. At the time of Abe’s passing, the home has a fair market value of $200,000.00. Brad will receive the home from Abe with a basis of $200,000.00. Absent a step up in basis, Brad would inherit the home and would be liable for the tax on the gain in the home’s value, which was $100,000.00. With the step up in basis in place, Brad’s basis in the home would be $200,000.00, and if Brad were to sell it the following day, Brad would not be taxed on the gain between Abe’s purchase price of $100,000.00 and the fair market value of $200,000.00 at the time Brad inherited the home. However, were Brad to turn around and sell the home for more, any amount above $200,000.00 would be taxable as capital gain to Brad.
Assets such as stocks may also receive a step up in basis. For example, Carla purchased stock in XYZ Corporation in 2005 for $10/share. In 2020, Carla passed away and left all assets, including the stock in XYZ Corporation, to Darla. At the time of Carla’s death, XYZ Corporation was worth $100/share. In 2005, Carla’s basis in XYZ Corporation stock was $10/share. If Carla were to sell all shares in XYZ Corporation in 2020, Carla would realize a $90 gain on the sale of each share. However, Carla did not sell the shares in XYZ Corporation, meaning Darla will inherit the shares with a stepped-up basis of $100/share. Any capital gains Darla must pay on the shares in the future will be calculated based on Darla’s $100 basis as opposed to Carla’s $10 basis.
While the step of in basis is typically discussed in relation to assets that have appreciated, it is important to note that there may also be a step down in basis. In the above examples, if the fair market value of the assets at the time of either original purchaser’s death was below the purchase price, the parties inheriting the assets would receive them with the lower basis reflecting the lower fair market value of the assets at the time of death.
In September 2021, the House Ways and Means Committee submitted a proposal to increase the capital gains tax rate to 25%. Further, congress members have called to completely repeal the stepped-up basis at death. Repealing stepped up basis would subject inherited assets to capital gains tax, which will likely increase under the current administration.
For more information regarding this or any other estate planning or corporate business matter, please contact us at 404-255-7400 or email us at info@hoffmanestatelaw.com.
