"Step-Up in Basis" Can Make Inheritance Better than a Gift

For heirs, receiving assets via inheritance helps them avoid capital gains taxes when they sell the assets they received.

In contrast to late 2012, when tax and economic uncertainty prompted many persons to make end-of-the-year gifts to their children and others, today an increasing number of financial experts are advising their wealthy clients to set up an inheritance for their heirs instead of making a direct gift.

Pursuant to the tax law passed in December 2017, the estate tax exemption for 2024 is $13.61 million for an individual and $27.22 million for a married couple. Large gifts that reduce an estate for tax purposes no longer make as much sense as they did just two years ago, when many people were anticipating a sharp decrease in the estate tax exemption. At that time, the wealthy seemed to be giving away everything from real estate to securities to art and other valuables - so much so that some estate planning advisers struggled to find enough qualified appraisers to help their clients set up the gifts.

Step-Up

For heirs, receiving assets via inheritance helps them avoid capital gains taxes when they sell the assets they received, as they can take advantage of a popular tax break known as the “step-up in basis.” The tax benefit stems from the heirs’ ability to set the value of their inherited asset - e.g., stocks or a house - at its fair market value at the time of the inheritance, rather than what it was worth when the decedent acquired it.

Consider this example: Dad bought the family home in 1950 for $6,500. Today it's worth $350,000. If the purchase price provided the basis for capital gains, the tax hit would be enormous when the heirs decided to sell the inherited house. With the step-up in basis to the house’s value at the time it was inherited, they would save thousands, perhaps tens of thousands, in tax dollars.

Using the step-up in basis advantage is a way to make the inheritance more powerful, and thus longer lasting, than a simple gift.

Adapted from the Daily Plan-It newsletter