Taking Advantage of Step-Up Basis: The Basics of Basis

I hope you are all having a wonderful start to the New Year. Upon advising clients as to the most prudent methods to plan their estate, the topic of “basis” is often discussed. I thought I would take a few moments to explain the meaning and significance of basis, in the most succinct way possible. Should you have any questions, feel free to call and we can chat about the basics of basis. Until then, happy learning!

What Is Basis?   Put simply, basis is the cost to purchase an asset. It is the price you pay when you buy something. For example, if you purchase stock, the basis is the purchase price, plus costs and fees.

How Are Taxes Calculated at the Sale of Asset? Basis is important because upon the sale of an asset, tax liability is calculated based on the increase from the basis (cost) to the sale price.

Step-Up and Carry-Over Basis, What’s the Difference? In estate planning, there are two important “transfer of basis” rules: 1. Step-up basis and, 2. Carry-over basis. Meaning, when one transfers or sells an asset, tax liability is assessed based on the two aforementioned basis methods.

Step-up basis Applies at Death: This method of assessing tax liability imposes taxes based on the rule that when one receives assets at the death of the grantor (person giving the asset), the basis for such asset is stepped up to the value at grantor’s time of death. Simply put, if dad buys property in 2000 for $100,000 (basis), he dies in 2016 and the property is worth $200,000, his son who inherits said property would receive the property at a “stepped-up” basis from $100,000 to $200,000, thus benefiting from no capital gains liability.

Carry-over Basis Applies During Life: On the other hand, if dad decided to transfer aforementioned property in 2016, one day before his death, his son would “carry-over” dad’s basis of $100,000. If he sells the property for $200,000 he would have a capital gains liability of $100,000. In short, during life transfers carry-over their basis. The smaller the difference between the basis and the sale price, the less tax liability.

Therefore, timing matters. In the above-mentioned case, had an attorney advised dad to wait to transfer his property at death, rather than gifting during his lifetime, his son would have benefited from inheriting property at a stepped-up basis, thus greatly limiting or eliminating capital gains liability all together.

Take away: Timing is everything. It is important to remember that if your estate falls below the federal tax exemption of $5.45 million (2016), it may be more generous to give at the time of your death, rather than during your lifetime.

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