Step-Up in Basis and Why It Matters in Estate Planning – ElderLawAnswers.com

insurance

Cabin at top of snowy mountain with a view.Recent news stories may have made you aware of the “step-up in basis” and the current administration’s desire to eliminate or adjust it.
If you are considering engaging in estate planning or you may be inheriting assets, it is important to understand what the step-up in basis is and how it may affect you.
The step-up basis is a provision in federal tax law. It determines how assets are valued for calculating capital gains taxes when a person passes away, leaves these assets to heirs, and those assets are sold.
Local Elder Law Attorneys in Your City
Firm Name
City, State
Firm Name
City, State
Firm Name
City, State
So, for example, imagine a person passes away and leaves their home to their children through their will.
When the children inherit the property, the home’s cost basis changes. (“Cost basis” is the amount for which an item is originally purchased.) The home’s cost basis is adjusted – or “stepped up” – from what it was valued at when the parent originally purchased the home to its fair market value on the date the parent died.
In this case, suppose the original cost of the home 30 years ago was $100,000, and the “stepped up” basis in 2022 (date of death) is $300,000.
If the children then sell the home for $500,000, the resulting capital gains liability is calculated by subtracting the stepped-up basis from the sale price. This determines the children’s taxable gain ($500,000 – $300,000 = $200,000 gain). The effect is that the capital gain between the original purchase of the home and the children’s receipt of it is eliminated.
In other words, without the step-up in basis, the children who inherited the property would have had a considerably higher taxable gain after the sale ($500,000 – $100,000 = $400,000 gain). As a result, they would then have potentially had to pay more in capital gains tax.
Passing assets, such as the home in the example above, to your loved ones through your will or estate plan means those who inherit are often subject to much lower capital gains tax than if the assets were outright transferred or given to your loved ones during your life.
This is because assets transferred or gifted before death are subject to the purchaser’s cost. Capital gains tax is then calculated based on the differential between the original cost basis and the sale price (after considering any depreciation or other capital gains exclusions that may apply).
The step-up in basis can apply to many kinds of assets, including:
Gifting or bequeath these types of assets through your will or estate rather than giving them away during your life can make a big difference for your heirs.
In addition, under federal law, all community and marital property gets a new basis when the first spouse dies. Their death brings the property up to the fair market value at that time. So, a surviving spouse could sell these assets and take advantage of this adjusted basis. And, subject to certain exceptions, the qualifying property of the surviving spouse can also receive a second step-up in basis at their death.
While some assets qualify for a stepped-up basis, some can lose the ability to receive an adjusted basis.
For example, a surviving spouse cannot benefit from a second step-up in basis for assets that had been placed into an irrevocable trust before the first spouse’s death.
The stepped-up basis also does not apply to the following types of assets:
Capital gains are taxed when an asset is sold (for a profit).
In the above example, if the house is sold three years after the parent’s death for $700,000 (which would mean it increased in value by an additional $400,000 during this time), then capital gains tax is potentially due on $700,000 (sale price in 2025) – $300,000 (stepped-up basis at date of death) = $400,000 of gains.
It is assessed and payable for the tax year in which the post-death sale occurred, and liability effectively shifts to the heirs who benefit.
Many believe the stepped-up basis creates an inequitable tax loophole that allows people with significant assets to shelter these assets from capital gains tax if they dispose of them through their estate.
For example, in the scenario above, if the home was initially purchased for $100,000 and sold by the heirs of the purchaser for $1,000,000 shortly after the purchaser’s death, $900,000 of capital gains would effectively never be taxed.
Meanwhile, someone who sell their assets during their lifetime will likely not get equal tax benefits (even considering the $250,000 personal residence capital gains exclusion) and may face a hefty capital gains tax bill.
On the other side of this argument are those who posit that not having a stepped-up basis can lead to double taxation. From their viewpoint, heirs or an estate would face capital gains tax as well as potentially significant estate tax.
This would likely only affect those with a good amount of wealth, given the current federal estate and gift tax exclusion, which will rise from $12.06 million in 2022 to $12.92 million in 2023. Most people will not fall into this category. Because of this, the tax revenue that the government could raise by eliminating the step-up-basis could arguably outweigh the double taxation issue.
However, this could all change after 2025, when the federal exclusion is set to be cut by approximately half. This will potentially affect a much larger group of people. The argument may not be so strong under those circumstances.
Planning to avoid capital gains taxes is a complex endeavor that a person should only undertake with the assistance of a qualified professional. Every person’s situation is different, and there is no one-size-fits-all solution.
While saving money on capital gains may seem attractive, there may be situations where leaving assets to heirs upon your death may not be the best plan or may create more significant tax issues. In addition, it may not be the best strategy if, for example, you need to engage in Medicaid planning.
Contact your attorney for answers to questions about capital gains taxes and whether you or your loved one may benefit from a step-up in basis.
An increasingly popular hybrid product combines life insurance with long-term care coverage and offers buyers solutions to a…
No parents want their children to fight among themselves after they are gone. Sadly, conflicts often arise, especially when a…
Are you having difficulty getting the pension or 401(k) plan funds you worked years to earn? Five pension counseling projects…
Although it is often said that nothing is certain except death and taxes, the one tax you may be able to avoid or minimize mo…
Need more information?
Subscribe to Elder Law
Updates.
Find an elder law attorney in your city.
Learn more about our practice development tools for elder law attorneys.
In addition to nursing home care, Medicaid may cover home care and some care in an assisted living facility. Coverage in your state may depend on waivers of federal rules.
To be eligible for Medicaid long-term care, recipients must have limited incomes and no more than $2,000 (in most states). Special rules apply for the home and other assets.
Spouses of Medicaid nursing home residents have special protections to keep them from becoming impoverished.
In addition to nursing home care, Medicaid may cover home care and some care in an assisted living facility. Coverage in your state may depend on waivers of federal rules.
To be eligible for Medicaid long-term care, recipients must have limited incomes and no more than $2,000 (in most states). Special rules apply for the home and other assets.
Spouses of Medicaid nursing home residents have special protections to keep them from becoming impoverished.
Careful planning for potentially devastating long-term care costs can help protect your estate, whether for your spouse or for your children.
If steps aren’t taken to protect the Medicaid recipient’s house from the state’s attempts to recover benefits paid, the house may need to be sold.
There are ways to handle excess income or assets and still qualify for Medicaid long-term care, and programs that deliver care at home rather than in a nursing home.
Careful planning for potentially devastating long-term care costs can help protect your estate, whether for your spouse or for your children.
If steps aren’t taken to protect the Medicaid recipient’s house from the state’s attempts to recover benefits paid, the house may need to be sold.
There are ways to handle excess income or assets and still qualify for Medicaid long-term care, and programs that deliver care at home rather than in a nursing home.
Most states have laws on the books making adult children responsible if their parents can’t afford to take care of themselves.
Applying for Medicaid is a highly technical and complex process, and bad advice can actually make it more difficult to qualify for benefits.
Medicare’s coverage of nursing home care is quite limited. For those who can afford it and who can qualify for coverage, long-term care insurance is the best alternative to Medicaid.
Most states have laws on the books making adult children responsible if their parents can’t afford to take care of themselves.
Applying for Medicaid is a highly technical and complex process, and bad advice can actually make it more difficult to qualify for benefits.
Medicare’s coverage of nursing home care is quite limited. For those who can afford it and who can qualify for coverage, long-term care insurance is the best alternative to Medicaid.
Distinguish the key concepts in estate planning, including the will, the trust, probate, the power of attorney, and how to avoid estate taxes.
Learn about grandparents’ visitation rights and how to avoid tax and public benefit issues when making gifts to grandchildren.
Understand when and how a court appoints a guardian or conservator for an adult who becomes incapacitated, and how to avoid guardianship.
We need to plan for the possibility that we will become unable to make our own medical decisions. This may take the form of a health care proxy, a medical directive, a living will, or a combination of these.
Distinguish the key concepts in estate planning, including the will, the trust, probate, the power of attorney, and how to avoid estate taxes.
Learn about grandparents’ visitation rights and how to avoid tax and public benefit issues when making gifts to grandchildren.
Understand when and how a court appoints a guardian or conservator for an adult who becomes incapacitated, and how to avoid guardianship.
We need to plan for the possibility that we will become unable to make our own medical decisions. This may take the form of a health care proxy, a medical directive, a living will, or a combination of these.
Understand the ins and outs of insurance to cover the high cost of nursing home care, including when to buy it, how much to buy, and which spouse should get the coverage.
Learn who qualifies for Medicare, what the program covers, all about Medicare Advantage, and how to supplement Medicare’s coverage.
We explain the five phases of retirement planning, the difference between a 401(k) and an IRA, types of investments, asset diversification, the required minimum distribution rules, and more.
Find out how to choose a nursing home or assisted living facility, when to fight a discharge, the rights of nursing home residents, all about reverse mortgages, and more.
Understand the ins and outs of insurance to cover the high cost of nursing home care, including when to buy it, how much to buy, and which spouse should get the coverage.
Learn who qualifies for Medicare, what the program covers, all about Medicare Advantage, and how to supplement Medicare’s coverage.
We explain the five phases of retirement planning, the difference between a 401(k) and an IRA, types of investments, asset diversification, the required minimum distribution rules, and more.
Find out how to choose a nursing home or assisted living facility, when to fight a discharge, the rights of nursing home residents, all about reverse mortgages, and more.
Get a solid grounding in Social Security, including who is eligible, how to apply, spousal benefits, the taxation of benefits, how work affects payments, and SSDI and SSI.
Learn how a special needs trust can preserve assets for a person with disabilities without jeopardizing Medicaid and SSI, and how to plan for when caregivers are gone.
Explore benefits for older veterans, including the VA’s disability pension benefit, aid and attendance, and long-term care coverage for veterans and surviving spouses.
Get a solid grounding in Social Security, including who is eligible, how to apply, spousal benefits, the taxation of benefits, how work affects payments, and SSDI and SSI.
Learn how a special needs trust can preserve assets for a person with disabilities without jeopardizing Medicaid and SSI, and how to plan for when caregivers are gone.
Explore benefits for older veterans, including the VA’s disability pension benefit, aid and attendance, and long-term care coverage for veterans and surviving spouses.

source

Leave a Reply

Your email address will not be published. Required fields are marked *