The “step-up in basis” is a tax provision that allows certain types of assets to be bequeathed by owners to their heirs at current market values rather than their original purchase price, or “basis.” For example, if a house that cost $300,000 initially, including any improvement costs, is bequeathed at its current market value of $500,000, the heirs’ basis in the home is $500,000. That means they could turn around and sell it without being responsible for the $200,000 capital gains on the property. If they later sell the property for $750,000, they will have a $250,000 capital gain.
Assets that are transferred before the owner’s death do not qualify for a step-up in basis, making the recipient responsible for taxes on gains above the owner’s original cost.
That’s why step-up in basis is such a vital estate planning tool. It can be especially important for assets that have gained significant value over time. However, not all assets are allowed such treatment. To optimize your estate plan for your heirs, it would be essential to know how various types of assets are treated by the IRS.
Assets that Qualify for a Stepped-Up Basis
Most real properties qualify for a stepped-up basis as long as they are transferred to heirs following the property owner’s death. These assets include:
- A family residence
- Rental properties, including multi-family apartment buildings and multiplexes
- Medical and other types of office buildings
- Retail centers
- Hospital properties
Most investment assets qualify as well, including:
- Stocks, bonds, ETFs, and mutual funds
- Businesses and equipment
- Collectible art and antiques
- Assets held within a revocable or living trust
Assets that Don’t Qualify for a Stepped-Up Basis
Generally, wealth accumulation vehicles such as 401(k) plans and IRAs are not eligible for a step-up in basis. The logic behind their exclusion is that their owners have already enjoyed significant tax breaks while they’re alive. All amounts inherited from a pre-tax retirement plan will be taxable as ordinary income to the beneficiary, whereas Roth accounts will pass to the beneficiary tax-free if certain conditions are met.
The assets that don’t qualify for a stepped-up basis include:
- Retirement accounts—i.e., IRAs, 401k)s, 457 plans, and 403(b) plans
- Pension plans
- Tax-deferred annuities
- Certificates of deposit
- Money market accounts
- Assets held in irrevocable trusts
The Bottom Line
The step-up in basis is a legal tax loophole that enables assets to bypass capital gains taxes when they are passed on to heirs. It can be one of the most effective ways to utilize the tax code to protect assets from taxes and preserve wealth for heirs.
Because not all assets are treated the same under the step-up in basis provision, it would be essential to seek the guidance of a qualified tax or financial advisor. By planning ahead, you can help ensure your assets receive the most favorable tax treatment when passed on to your heirs.
At URS Advisory, we help individuals, couples, and families on the Treasure Coast and the Palm Beaches plan ahead for these types of estate planning considerations so their heirs are not faced with huge tax liabilities upon inheritance. If you or a loved one is in need of guidance in this area, we encourage you to schedule a call with us today.
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All content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. URS Advisory does not offer tax planning or legal services but may provide references to tax services or legal providers. URS Advisory may also work with your attorney or independent tax or legal counsel. Please consult a qualified professional for assistance with these matters.