To understand a step up in basis and how you can benefit from it, we first have to define what the terms “basis” and “taxable gain” mean. Basis is the cost of an asset from which taxes are calculated; taxable gain is the profit of an asset that is subject to capital gain tax.
Here’s an example
Your mom bought a stock in ABC Company for $100. The cost of her stock – $100 – is considered her basis. After 7 years, she decides to sell the stock. The market value for ABC Company stock is now $250. Because taxable gain is the selling price minus the basis, when your mom sold her stock, she had a taxable gain of $150.
Now let’s say that your mom held the stock until her recent death and you inherit the stock from your mom. On the day of her death, the stock is still valued at $250. According to IRS rules, you now own the stock with a stepped-up basis of $250 because the IRS allows the person receiving the asset (the beneficiary) to receive the asset with a step up in basis to the value of the asset on the benefactor’s date of death.
How does this benefit you?
A higher basis means you have less taxable gain when you go to sell. In this case, we’ll assume you decide to sell the stock after inheriting it from your mother. ABC Company stock increases in value and you end up selling the stock for $300. Because of your step up in basis, your potential taxable gain is only $50 ($300 selling price minus the $250 step up in basis), rather than the $200 potential gain you would have without the step up in basis ($300 selling price minus your mom’s original $100 basis).
How to lose out on the step up in basis?
For the step up in basis to occur, the asset must be owned by the benefactor at the time of his or her death. It can’t be owned by the beneficiary. If your mom had made her asset a gift to you while she was still living, you would retain the original basis of $100. You can see how receiving this gift during your mom’s lifetime may not be in your best interest!
Are you considering how best to leave your assets to your children or other heirs? Consider the step up in basis rules and talk to your CERTIFIED FINANCIAL PLANNER™ Practitioner or attorney to make sure all of your assets pass to your heirs in the most advantageous way.
Andrea L. Blackwelder, CFP®, ChFC and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with Wisdom Wealth Strategies.