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Step Up In Basis

Tax planning is an important component of an overall estate plan. Depending on the type and the value of assets owned, the services of an attorney and a tax specialist may be appropriate.  Throughout the Northshore of Massachusetts, including Saugus, Danvers, Wakefield and Lynnfield, it may save significant money and gifts for heirs if one works with an experienced estate planning lawyer. Any number of life events may provide a good time to trigger setting up an appointment to review your estate and discuss options – marriage, divorce, an addition to the family, health issues or simply natural aging.

commerce-acts-books-477966-mOne example of a tax planning issue to consider is the taxable basis at death of assets acquired during one’s lifetime, such as stocks, a home and real estate. A properly prepared estate plan may enable the heirs to use a legal step-up in basis so that the starting point for valuation of an asset will be the value at the date of death – instead of the value at acquisition or some other starting value.

What is a step-up in basis and how does it work?

Your basis is usually what you paid for the asset. According to the IRS, a capital gain or loss is the difference between your basis and the amount you get when you sell an asset. In other words, if you sell an asset that is worth more than you paid for it, you will have to pay taxes on the gain.

While capital gains taxes can be significant, it is possible to avoid this tax altogether — let your heirs inherit the asset. When someone inherits an asset, the cost basis of the asset is “stepped up to value” on the date of death.

For example: Grandpop purchased his home in Lynnfield for $20,000 in 1950.  In 2017, when he passes, the home is worth $520,000.  Without proper tax planning and without a will, Grandpop’s heirs who inherit the house may have to pay a capital gain tax on $500,000 when they sell the property– greatly reducing the value of the gift. However, with proper planning to take advantage of the step-up in basis, the house could be gifted to the heirs as an inheritance.  The heirs will then start with an automatic step-up in basis to the market value of the house at the date of grandpop’s death. In that situation, when the heirs sell the house they would only pay tax on any increase in value from date of death to date of sale – often a negligible amount.

In general terms there are two components to tax planning for an estate. The “estate tax” which is a federal tax against the assets in the estate at the date of death and paid out of the assets of the estate; and (depending on the State) an “inheritance tax” which is a tax against the recipient of a gift from an estate. The recent election cycle brought a flurry of news about the estate tax, with some suggesting that the President-Elect may look to do away with the inheritance tax completely. This aspect of estate planning is often in flux and changes year by year and with each administration. However, regardless of what happens with the federal estate tax, the risk of having to pay a capital gain tax upon the sale of stocks or a house that was received by an heir of an estate, remains a potential issue. One common mistake made is to put the house into joint ownership with the parent and children, often with the goal of avoiding probate. While this goal may be accomplished, it may also cause the children to lose the step-up in basis and end up costing them a lot of money. Effective tax planning can reduce or minimize this tax by utilizing legal benefits of a step-up in basis. Consult with an estate lawyer who can advise you as to the options for proper estate tax planning to lighten the tax bite.

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