What is the Step-Up in Basis?

Senior Law News | Jun 18, 2021 | Shannon Laymon-Pecoraro, CELA

There has been a lot of talk about Congress eliminating the step-up in basis.  Although this is touted as a wealthy man’s loophole, many of my clients may be significantly impacted if such a law is passed, however, very few actually understand the effects.

The first step in understanding the implication of this proposed change to the tax law is to understand what “basis” actually refers to. Cost basis is the original value of an asset for tax purposes, usually the purchase price subject to adjustment by a list of various things. So, for example, assuming you are a single individual and you bought your house for $100,000 and put $50,000 of additional work into the house, your cost basis would be $150,000. This value is used to determine the capital gain, which when realized, is subject to a capital gains tax. Essentially, the capital gains tax is a tax imposed on the difference between the asset’s cost basis and the realized price at the time of sale. So, if you later decided to sell your house, and sold it for $500,000, you will have a realized gain on that sale of $350,000. For a primary residence, there is a $250,000 capital gain exclusion, and as a result, you would be subject to a tax on $100,000 worth of capital gains.

In general, when assets are transferred from one individual to another, you receive a “carryover basis.” So, if prior to the sale of your house, you gifted your house to your only child, your cost basis will “carryover” to that child. The child therefore has a $150,000 cost basis in the newly transferred house. Your child, who has not used the house as their primary residence, now sells the house at your death for $500,000. The child will now have a realized capital gain of $350,000, subject to a capital gains tax.

Now assume you held onto your house, and at your death, the house passed to your only child. Under current tax law, the cost basis for your child is “stepped up” to the fair market value of your house at the time of your death. So, if at the time of your death your house is valued at $500,000, your child inherits a cost basis of $500,000. As a result, when you child sells the newly inherited house for $500,000, there is no capital gain. 

Many of the estate and long-term care plans we develop are intended to preserve this step-up in basis and therefore minimize capital gains on inherited assets. Although I used real property in my example to simplify a complex topic, the capital gains tax applies for most appreciable assets. Biden’s proposal seeks to repeal the step-up in basis for capital gains in excess of $1 million.  Considering there are unrealized capital gains in real property, businesses, investment accounts, etc. the elimination of the step-up in basis can have a significant impact on the future of wealth transfers in America.

Ask the Attorney: Do I need to update my estate planning documents if my child changes their name or moves?

People get married, divorced, and move, resulting in name and address changes. Our clients often ask us how these changes impact their documents. The good news is that although life happens, these minor little things may not necessarily impact your documents. Proper documentation can prove the name of an individual, or address, at the time your documents were created. As a result, the main rule of thumb is that as long as anyone can confidently identify the person named in the document, it is generally sufficient to leave the document as-is.

Ask Neo

Hook Law Center: Can humans donate their old pace makers to dogs?

Neo: Yes! There is a donation program at the University of Georgia’s College of Veterinary Medicine, that receives previously used devices and then uses them for dogs in need. Cardiac nurse, Terri Mattula, thought of just this and donated her husband’s old pacemaker to the University which now has a program specific to this purpose. This is not only life saving to the dogs but more cost efficient for the pet’s parents.  Read the story here: https://www.cnn.com/2019/05/10/health/georgia-pacemakers-donations-pets-trnd/index.html

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