A step-up in basis, or more accurately, a basis adjustment, has been a cornerstone of many estate plans throughout the years. Let’s take a look at what a basis adjustment is, how a step-up in basis works, and some recent news about its possible demise.
The basis of property is a tax term and it is the amount that someone paid for it. If that property is later sold, capital gains or losses must be reported. This would be an amount taxed on the difference of the original basis amount and the amount of the sales price.
However, a basis adjustment occurs when the property is inherited. Meaning, the beneficiary of that property receives it with a basis of its current fair market value instead of its original purchase price. Let’s look at an example. Nancy bought stock in XYZ Corp. in 1970. She paid $100,000 for it. It is now worth $500,000. If she sold it this year, she would have to pay capital gains tax on the $400,000 profit. Instead, if Nancy died this year and her son inherited the property, he would take the property with a basis of $500,000. He received a step-up in basis. Nancy’s son could then sell the property at its fair market value of $500,000 with no capital gains tax due.
A basis adjustment can even be preserved in irrevocable trust planning. In the EC Medicaid Asset Protection Trust®, a basis adjustment is achieved via reserving a limited power of appointment. Per Treasury Regulation 25.2511-(b)(2), a limited power of appointment is an incomplete gift. An incomplete gift means that the Grantor never relinquished full control of that asset and it will be included in his estate. If assets are includable in the Grantor’s estate, then the assets qualify for a step-up in basis. (See 26 US Code § 1014(b)(9). (While this planning is generally desirable, if the estate is subject to estate tax, then a decision will need to be made: Is a basis adjustment more desirable or is the avoidance of estate tax?)
There has been big news recently that there may be an end to the step-up in basis when property is inherited. The Sensible Taxation and Equity Promotion (STEP) Act has been introduced in the Senate. It proports to tax any transfer of property, including at death. However, there would be a $1 million exclusion for inherited property.