Cost Basis Step-Up

What’s the single biggest expense that you will incur during your lifetime? You guessed it, taxes! Nobody enjoys giving away their hard earned dollars to the Tax Man. This is all the more reason to take advantage of any rare instances where tax implications can be minimized. A step-up in cost basis on inherited assets (from a decedent) is a prime instance where your tax liability can be reduced. This commonly overlooked tax benefit can be advantageous to a beneficiary when inheriting assets and it is crucial to understand when and how to effectively implement this strategy.

What exactly is a step-up in cost basis and how is this beneficial? Defined as the readjustment of the market value of an appreciated asset for tax purposes upon inheritance, a step-up in cost basis values the asset using the cost basis at the time of inheritance rather than the value at the time of purchase. It is very important to understand that this tax benefit only applies to appreciating assets, such as securities and property.

Often times, when an asset gets passed on to a beneficiary, its value tends to be greater than the value at which the original owner had acquired it at. For example, your friend’s Aunt has just passed away and left your friend 100 shares of Disney stock. The stock was originally purchased for $50.00 and the current market value is $100.00. The $50.00 difference between the purchase price and market price is defined as the capital appreciation and this is the component that the beneficiary will have to pay capital gains taxes on. But what if we could reduce the amount of that capital gain? Can we also reduce the amount of the capital gains taxes owed?

The answer is yes; this is exactly where the step-up in basis comes into play. On the day your friend’s Aunt passed away, the Disney share price was $90.00. With a stepped-up cost basis, the asset’s cost basis is now the market value as of the date of the decedent’s death ($90.00) and not to be confused with the current market value ($100.00). Instead of your friend paying capital gains taxes on a $50.00 gain, he is only responsible for paying taxes on the $10.00 capital gain. The adjusted cost basis has decreased the size of the capital gain and the capital gains taxes which go along with it.

As a beneficiary inheriting assets, it is very important that you remain aware of the limitations associated with a step-up in cost basis. One important rule to note is that this tax benefit does not apply to any assets that are held jointly with children. In addition, you cannot apply a step-up in basis to any tax-deferred, qualified retirement account. This means that you will not be eligible to receive a step-up in cost basis on any IRAs, 401(k)s, 403(b)s or any other qualified account. Lastly, you must be aware of the fact that assets can also receive a “step-down” in cost basis. This is simply the opposite of a step-up in cost basis.

Although this tax rule is not one that an inpidual uses regularly, it is still important to be cognizant of the fact that it exists. Be sure to view the latest Mitlin Minute to learn more about a step-up in cost basis. If you think that you, or someone you know, may be eligible to receive a step-up in cost basis on recently inherited assets, it would be wise to consult with your financial advisor on how to proceed. You may also want to give us a call (631) 952-4466 x12 to see how Mitlin Financial, Inc. can help you in these types of scenarios. Contact us today and see how we can help facilitate and maintain your financial future!

Disclaimer: This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.