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Step Up in Basis at Death | Capital Gains Tax

Attorney Thomas B. Burton explains how Step Up in Basis at Death works for appreciated assets and the capital gains tax benefits to your heirs of using this method to pass highly appreciated property as part of your estate planning upon death. In this video Attorney Burton explains the valuable Step Up in Basis or "New Basis at Death" rules for capital gains tax currently in place with the IRS, and explains why gifting highly appreciate assets during life can sometimes turns into an unexpectedly large capital gains tax bill for your heirs when they later go to sell the asset.

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Welcome back, I'm Attorney Thomas Burton.

I'm an estate planning and asset protection attorney in Wisconsin and today's topic is 'What is step up in basis at death?'

So many of you maybe have heard this term, 'step up in basis at death' or 'new basis at death' and it's a tax law concept that has to do with capital gains tax, owed on property held for a long term at death.

So in the United States, property held over one year is generally subject to long-term capital gains tax upon the sale, however one of the great reasons to leave appreciated property at death is there's a step up in basis at death for long-term capital gains for property held and gifted to someone upon your death.

So to see how this works, let's go through an illustration.

Now, this can apply to all kinds of appreciated property, any property and in general we talk about a step up in basis because if you hold an asset a long time, generally it goes up, not always. So I had a law professor who emphasized it, should actually be called 'new basis at death' because you receive a new basis equivalent to the fair market value of the asset, on the date of death. This is why it's important if someone passes away, to establish that date of death and get the asset value of everything they owned as of that date of death, because that's what we go by, according to the tax law.

So in some instances, an asset can decline and the new basis at death can be lower but for a lot of people, if they held investments such as stocks, bonds or real estate, a lot of times the asset goes up and that's why in the common terminology, you hear 'step up in basis at death'.

So here's how it works, the tax basis for an asset for long-term capital gains is generally established by the price you paid at the time you bought it and then with real estate, you can also factor in improvements you make to the property but here's some common types of assets - stocks, bonds, real estate. So for our example we're going to say 1980, you bought a stock at $10 a share, a bond for a $100, real estate for a $100,000 and then let's say, in 2020, the stock is worth a $100 a share, the bond is worth $200 and the real estate's worth $200,000. So capital gains tax would be the tax on the difference, the profit you make from what you paid to what you sell it for, in that year. So that's the general rule, if you buy and sell an asset for capital gains.

Now here's where people can sometimes inadvertently cause a tax issue for their heirs, they want to gift an asset to their heir during life and there can be reasons to do this if you're approaching estate and gift tax limits but the limit for individuals in 2021, is $11.7 million. So for many middle class people, they aren't close to that limit but let's say, you decide you want to give a hundred shares of your stock to your son or daughter in 2010 and in 1980 again, your basis was $10 a share, well, when you give it to them in 2010, they take your basis, they get your basis of $10 a share and let's say then in 2011, they needed the money. Got laid off and they sold the stock for $90 a share. Well they get to deduct your basis of $10 a share and they made $80 a share, long term capital gains of 15% which would be $12 of tax per share or $12,00 for one hundred shares.

Now 15% is the capital gains, long-term capital gains tax rate for folks making between $40,000 to 4,41,000. So for most people, they fall into that 15% tax rate but be aware, if you're under zero to $40,000, it's zero percent and then above $4,41,000, it's as high as 20% but I'm using 15% as a common example to do the math because it applies to a lot of folks.

So that's an example, if you gifted that asset, in this case stock during life. Now we can see big taxes often with this, when you do it with real estate because often real estate appreciates over time and the numbers are even bigger. There I was just using the example of a hundred shares at ten dollars a share, it's not such a big tax but if you think about my house example, a hundred thousand to two hundred thousand, 15% on that gain is $15,000.

So with real estate, often leaving it at death makes sense for getting the new basis at death for highly appreciated real estate.

Now let's look at what happens with the stock, if you gift it at death through your will or trust instead. The gift recipient, your heir in this case, would get the new basis step up in basis at death, so 1980, $10 a share. 2020, the valuation rose to a $100 a share. So let's say they sell it shortly thereafter for exactly $100, we'll make this simple, it might be you know, 101/102 however, if it goes up, goes down a little bit but for this a $100 a share, they got that new basis at your day to death, they took a snapshot of the stock market, it was a $100 on the day you died in 2020. So their capital gains ends up zero dollars and the capital gains tax, let's say, they're in the 15% bracket, zero dollars.

So by leaving assets at death, especially highly appreciated assets, your heirs can get a significant tax break upon death and the same with the house example, I mentioned earlier, if you had a $100,000 gain on that real estate, that would be 15% capital gains and instead of gifting it to them via a Quitclaim deed, let's say, in 2010, you left it through your will or trust in 2020, no capital gains on the sale if they get that new basis at death and the way to establish new basis for a stock, it's fairly simple to look at the market price on the date you died but for a house, you're going to want to get it reappraised as of the date of death for the heirs to get that higher value locked in and have paperwork to show to the IRS, this was the fair market value as of date of death.

So step up in basis at death or new basis at death, to please my professor but step up in basis, the commonly known term is a powerful concept in the tax law and one of the best tax breaks out there and why many people choose to leave property at death to their heirs rather than do lifetime gifting. Now if you have an asset that hasn't appreciated much, that might be appropriate for a lifetime gift situation like cash for example. That's why cash is such a popular lifetime gift, you don't have that built-in basis type of thing but for a highly appreciated asset, which is often the case with things like stocks, bonds and real estate, you need to be aware of the capital gains tax consequences for an heir before you gift it to them and if it makes sense, it still makes sense, just make sure you've thought through all the reasons why you're doing that gift during life with your legal and tax advisors or whether it's better for a gift to leave at death.

So this is the current regime of step up in basis, new basis at death, under tax law. There's talk in the new administration of changing this, which would be a very big sea change in the world of estate planning and would change the way things are currently done but currently, under current tax law, as of January 2021, this is how step up in basis works and again, it's a powerful concept you can implement in your own estate and tax planning.

So I hope this video has been helpful to you. If it has, consider giving it a like and subscribing to our channel, so that more people can find and benefit from these videos as well.

Thanks for watching and we'll see you next time.

© 2021 Burton Law LLC. All Rights Reserved. Transcript and captions provided for ease of access for the hearing impaired. For questions about this topic, or to suggest a topic for a future blog post, please contact the office.


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