Step-Up in Basis

Step-up in basis or stepped-up basis refers to the adjustment to the cost basis of an asset to its fair market value when the asset is passed on to its heirs upon the death of the benefactor or the predecessor. It is a tax law popular in the United States.

The rule implies that the cost basis of an asset when it is with the heir will be different from the cost basis calculated for the benefactor. The provision’s significance arises when an heir deals with activities like selling inherited assets. To calculate the capital gain tax liability, they have to calculate the inherited asset’s basis differently.

• Step-up in basis refers to an IRS tax rule that allows updating the cost basis of an inherited asset to its fair market value on the date of the decedent's death.
• It benefits the heir or beneficiary by reducing the capital gain tax liability.
• The cost basis value or calculation generally depends on the benefactor's death date.
• The rule implies that the cost basis of an asset when it is with the heir will be different from the cost basis calculated for the benefactor.

Step-up in basis is a tax rule in the United States that allows taxpayers to have enhanced profit while selling the properties or assets like stocks or bonds which they didn't purchase but inherited. The law allows the asset's original cost basis to update to the one equivalent to its fair market value; if the cost basis has increased, the spread between the selling price and original cost decreases, and the capital gain and tax liability decreases.

The cost basis is the purchase price; specifically, it is the cost to the buyer or owner. For example, the basis includes purchase price, sales tax, and other expenses associated with the purchase. Adjusted basis happens when any events that occur during the period of ownership increase or decrease the basis. For example, any improvement activity can add value to the property, and items like depreciation can reduce the basis. However, if the property is obtained through inheritance rather than a purchase, the basis is not determined by the cost.

The tax calculation associated with the sale of inherited property involves the determination of the taxpayer's basis in the property. According to IRS rule, the basis of property inherited from a decedent is generally the fair market value (FMV) of the property on the date of the decedent's death or the FMV of the property on the alternate valuation date, but only if the executor of the estate files an estate tax return and elects to use the alternate valuation on that return. 

Rupert purchased a house in 1980 for $50,000 and maintained it in excellent condition. In 2022, the house's market value is worth nearly $250,000. When Rubert died in 2022, his grandson Robin inherited the house and sold it for $300,000; at a glance, there is a profit of $250,000 and capital gain tax liability.

The application of a step-up in basis tax provision resulted in the adjustment in the cost basis of the house to its fair market value on the date of Rubert's death, that is $250,000. Therefore, the house's purchase price or original value is $250,000. Capital gain is the difference between selling and purchase prices in simple terms. So, the capital gain is $50,000 ($300,000-$250,000), significantly reducing the taxes.

Suppose Rupert purchased shares of a stock for $1,000 in 2002 and sold it in 2012 for $5,000. The capital gain tax will be based on the gain value of $4,000. Instead of this scenario, If Robin inherited the shares after Rubert’s death in 2012, the cost basis of the shares inherited will be the fair market value, $4,500, and sold the shares for $5,000, the capital gain will be $500 ($5,000-4, 500).

The cost basis value or calculation generally depends on the benefactor's death date. The valuation method using the date of death involves identifying the asset's fair market value on the date of death. For example, the closing price of a stock on that date and the fair market value for a property is determined for that date, usually by an appraisal. For the benefactor, the cost basis for tax purposes will be the purchase price or the adjusted basis. Whereas, for the beneficiary, the cost basis for tax purposes will be its fair market value at the date of death.

This article has been a Guide to what is Step-Up in Basis. We explain step-up in basis provision at decedent's or spouse's death, tax calculations, examples, etc. You can learn more about accounting from the following articles –

• Living Trust
• Grantee
• Usufruct