When developing a comprehensive estate plan, it is important that you consider current tax laws. This will allow you to choose a strategy that will minimize your tax liabilities while also achieving your estate planning goals. One of the most important tax liabilities to consider is the potential of capital gains tax. Many successful estate planning strategies will minimize capital gains tax liabilities by taking advantage of what is known as a “step-up in basis.”


What is step-up in basis?

The readjustment, for tax purposes of an inheritance, of the valuation of an asset that has increased in value is referred to as a step-up in basis. This changes the valuation of the asset for tax purposes when the asset transfers ownership to an heir. A step-up in basis will take the value of the asset upon inheritance when calculating capital gains taxes when your heir eventually sells the asset in the future. 

How does step-up in basis work?

There are many types of assets that step-up in basis can apply to with one of the most common being real estate. Assume that you purchased a home for $250,000 which has continuously appreciated over the years. If by the time you pass away and the property is transferred to your heir the property is valued at $500,000, when your heir eventually decides to sell the property, this will be the cost basis used to determine the capital gains tax charged. 

Therefore, if your heir sells the home for $600,000 he will only be liable for $100,000 worth of capital gains for tax purposes. This means the first $250,000 in appreciation is exempt from capital gains tax liability. 


Community property states

Those who live in a community property state have the opportunity to take advantage of the step-up in basis rule twice. This happens when you and your spouse own an asset, such as a home, and your spouse passes away and full ownership of the home transfers to you. If you were not in a community property state, only half of the co-owned home would receive a step-up in basis. Alternatively, in a community property state, you would receive a step-up in basis of the entire home.


Then, when you eventually pass away, your heir will also receive another step-up in basis when he or she inherits the home. Essentially, your heir will benefit from a step-up in basis twice. 


Planning to take advantage of step-up in basis

As you can see, it is highly important to consider the step-up in basis rules when developing a comprehensive estate plan. You should also keep up with any changes to the rule that might affect your tax mitigation strategy. Working with a professional financial advisor can help you keep up to date. Failure to consider step-up in basis rules can result in your intended beneficiaries having to pay more capital gains taxes in the future than they otherwise would have had to. 


Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Independent Financial Services and First National Bank of Pasco and not necessarily those of Raymond James.