In our estate and probate practice, beneficiaries often ask whether they will have to pay taxes on assets that they inherit. The answer to this often depends on what type of asset is involved and whether there is a gain or a loss on the asset. When a person owns property and they devise it to someone at death, in determining whether there’s a gain or a loss for tax purposes, a determination must be made of the “basis” for the property. From the basis, it can be determined whether the value went up–a gain–or went down–a loss.
Fortunately, when an asset is inherited, its valuation gets what is called a “step-up” in basis. Most often, the value is established by looking at what the property is worth at the time the owner dies–not at the time it was purchased by the deceased owner. This can make a huge difference in tax liability, especially when an asset has appreciated significantly.
Fortunately, when an asset is inherited, its valuation gets what is called a “step-up” in basis. Most often, the value is established by looking at what the property is worth at the time the owner dies-not at the time it was purchased by the deceased owner. This can make a huge difference in tax liability, especially when an asset has appreciated significantly.
An example can demonstrate how a step-up in basis works. Tom owns a rental house which he purchased for $50,000 in 1972. When he dies in 2015, his Will leaves the house to his nephew. At the time of death, the house is worth $250,000. In determining the basis to the nephew, is it the $50,000 for which Tom purchased the house in 1972 or is it the $250,000 that it is worth at time of Tom’s death? Applying the concept of a step-up in basis, the property is valued for the nephew at $250,000. If the nephew sells the house for $250,000, he pays no taxes. If the nephew sells the house for $300,000, he will have a gain of $50,000 and may owe taxes. Using that same example, imagine if there were no step-up in basis. If the nephew sold the house for $250,000, then he would have to pay taxes on $200,000.
This example can also demonstrate the benefit of gifting an asset at death rather than during one’s life. If Tom gifted the house to his nephew in 2007 and it was worth $100,000 at that time, then when the nephew sells the house, his basis will be $100,000. So if the nephew sold it in 2015 for $250,000, then he could pay tax on the $150,000 gain. If the nephew received it by inheritance at Tom’s death, the nephew’s basis would be the date of death value.
In all of our estate and trust administration cases, we advise beneficiaries to seek counsel from an experienced tax accountant or CPA. In doing so, this assures that the handling of any step-up in basis is treated properly.
