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What is Step-up Basis and Why Does it Matter?

Oct. 18, 2022

When it comes to estate planning, one of the most important concepts to understand is step-up basis. What is step-up basis, and when does it apply? Why does it matter? In this blog post, we will answer these questions and provide some examples to help you better understand this important concept.

In general, step-up basis is the increase in the value of an asset at the time it is inherited. For example, if you inherit a house that was purchased for $200,000, and the value of the house increases to $300,000 by the time you inherit it, your "step-up" in basis would be $100,000.

This is important because it can affect the amount of capital gains tax that you owe when you sell the asset. For instance, if you purchased a home yourself, and it appreciated by $200,000 since its purchase, you would owe capital gains taxes on the full $200,000. However, when you inherit an asset, you will only owe capital gains taxes on the appreciation in value between your inheritance and the sale of the asset, potentially reducing your tax liability.

There are a few exceptions to step-up basis. One is if the asset was gifted to you during the owner's lifetime. In this case, you do not get a "steps up" in basis, rather you take the donor’s original cost basis in the asset. Another exception is if the asset was sold for less than its fair market value during the owner's lifetime. In this case, the basis "steps up" to the lower sale price, rather than to the fair market value at the time of the owner's death.

Finally, it's important to note that step-up basis only applies to assets that are inherited. If you sell an asset that you purchased during your lifetime, your basis will be the original purchase price, not the value at the time of your death.

Now that you understand what step-up basis is and how it works, let's take a look at why it matters in estate planning.

There are two main reasons why step-up basis is important in estate planning. First, it can help to minimize capital gains taxes. As we mentioned above, if you sell an asset that has increased in value, you will owe capital gains tax on the entire sale price. However, if you inherit the asset and sell it, you will only owe capital gains tax on the portion of the sale price that exceeds the step-up in basis.

Second, step-up basis can also help to maximize the value of an estate for tax purposes. This is because the value of an asset for estate tax purposes is generally its fair market value at the time of the owner's death. However, if an asset has appreciated in value since it was inherited, the estate may be liable for capital gains tax on the appreciation.

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If you have questions about step-up basis or any other aspect of estate planning, we can help. As an experienced estate planning attorney, I can advise you on the best way to structure your assets to minimize taxes and maximize the value of your estate. Please Click here to Schedule a FREE Virtual Estate Planning Session.


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