Understanding the ins and outs of the step-up basis rule can be a valuable tool for seniors and older adults planning their estates. The step-up in basis is a tax provision that allows widows to adjust the cost basis of their deceased spouse’s assets, potentially reducing or eliminating capital gains taxes. In addition to stocks and real estate, other investments may also qualify for the step up in basis. In this blog, we will cover the tax concept of step up in basis when a spouse dies.
By understanding the concepts related to step-up basis and seeking professional advice from an attorney specializing in estate planning or probate concerns like the team at Jones Elder Law, you can make smart decisions about your long-term care needs while minimizing potential tax burdens on your loved ones.
Understanding the Step up in Basis When a Spouse Dies
It’s important to know how to apply the step-up in basis to real estate assets and consider both jointly-owned and individually-owned property scenarios. Moreover, it’s essential to be mindful of any restrictions or exclusions when utilizing the step-up in basis.
How the Step-Up in Basis Works for Joint Accounts
When a married couple opens a joint account and purchases an asset like a stock, they may see significant appreciation over time. If one spouse passes away and leaves their shares to their widow(er), there could be substantial capital gains taxes upon selling those shares. However, with the step-up in basis, half of those shares would have their cost basis adjusted to reflect fair market value on the date of death.
Types of Assets Eligible for a Step-Up
Several types of assets are eligible for a step-up in basis upon inheritance:
- Real estate:If you inherit real property like your primary residence or vacation home from your deceased spouse, you may be able to take advantage of an adjusted cost basis on their share of ownership.
- Farm and hunting ground:Land used for farming or recreational purposes can also receive a stepped-up value when inherited by a surviving spouse.
- Mutual funds and ETFs:Similar to individual stocks, these investment vehicles can have their cost basis adjusted if they were owned jointly by spouses before one’s death.
To ensure that you’re getting the most benefits available through this tax provision, it’s essential to work closely with experienced professionals like the team at Jones Elder Law. By understanding how this works and what assets are eligible for a step-up, you can enjoy the benefits of this powerful tax strategy.
Benefits of Utilizing the Step up in Basis
Widows who take advantage of this tax rule can significantly reduce the tax liabilities on appreciated assets inherited from their late spouse. By reporting stepped-up values instead of original costs, they can avoid paying unnecessary capital gains taxes upon selling these inherited assets.
The primary benefit of using a stepped-up value is that it reduces or eliminates capital gains taxes when selling an asset. Capital gains tax is calculated based on the difference between the sale price and the cost basis (original purchase price) of an asset. When you inherit assets from your deceased spouse, taking advantage of a step-up in basis allows you to adjust the cost basis to fair market value at the time of death, thereby reducing or eliminating any taxable gain upon sale.
For example, let’s suppose a married couple purchased stock for $10 per share years ago. Now it’s worth $50 per share at the time one spouse passes away. If sold without considering a step up in basis, there would be a significant capital gain taxed at 15% – 20%. However, if properly reported with adjusted values after stepping up the share’s cost base, little-to-no tax may be owed upon sale due to reduced taxable gain.
Applying the Step up in Basis to Real Estate Assets
The step up in basis also applies to real property owned by married couples jointly or individually. Upon death, a widow may receive an adjusted cost basis on her late spouse’s share, which reduces taxable gain when selling property like primary residences, vacation homes, or farmland.
In cases where a couple owns real estate jointly with rights of survivorship, the surviving spouse automatically inherits their deceased partner’s share. The tax rule allows for half of the property value (the deceased spouse’s portion) to be increased to its fair market value at the time of death. This can significantly reduce potential capital gains tax liability upon selling the property.
Potential Benefits for Various Types of Real Estate
- Primary Residences:If you sell your primary residence after your spouse passes away and meets certain requirements (IRS Topic No. 701 Sale of Your Home), you may exclude $250,000 ($500,000 if filing jointly) from capital gains taxes using the step-up provision.
- Vacation Homes:Selling a vacation home inherited from your spouse can also benefit from the step-up in basis, reducing or eliminating capital gains taxes on any appreciation that occurred during your spouse’s lifetime.
- Farmland and Hunting Ground:If you inherit farmland or hunting ground from your deceased spouse, utilizing the step-up in basis can help minimize potential tax liabilities when selling these properties. This is especially beneficial for land that has appreciated significantly over time.
Applying the step-up in basis to real estate assets can provide a variety of benefits for those who are looking to transfer their property after death. However, there are some limitations and exceptions that should be taken into account when utilizing this rule.
Limitations and Exceptions to the Step Up In Basis Rule
While utilizing this tool can provide significant tax benefits for widows inheriting appreciated assets, it is important to understand that not all asset classes are eligible. There are certain limitations and exceptions where adjustments aren’t applicable. This may impact your overall estate planning strategy.
One notable exception involves retirement accounts such as IRAs, 401(k)s, and other similar plans. These types of accounts do not receive any adjustment upon inheritance. Instead, these funds will be included as income when distributed to beneficiaries and taxed accordingly without benefiting from reduced capital gains taxation.
Other Exceptions Where Adjustments Aren’t Applicable
- Inherited Property from a Non-Spouse:The step-up basis only applies when the property is inherited at a spouse’s death. If you inherit property from someone who is not your spouse (e.g., parent or sibling), then there might be no step-up available.
- Gifted Assets: If an asset was gifted rather than inherited at death (i.e., transferred during one’s lifetime), it generally does not qualify for a stepped-up cost basis.
- Certain Trusts:Some trusts may limit or eliminate eligibility for a stepped-up cost basis depending on their structure and provisions. Consult with an experienced estate planning attorney to understand the implications of specific trust arrangements.
By understanding which assets are eligible for this tax benefit and incorporating them into your overall estate plan, you can better protect your family’s wealth while minimizing potential excess tax burdens.
Planning Ahead with Estate Planning Strategies
Proactively incorporating the step-up in basis into your estate plan, along with other tax-efficient strategies, ensures that widows are well-prepared to navigate complex financial matters after their spouse’s passing. This foresight helps protect family wealth and ongoing legacy.
One of the key components of a comprehensive estate plan is considering how assets will be distributed and taxed upon death. By factoring in this tax strategy, you can ensure that your surviving spouse benefits from reduced capital gains taxes on inherited assets.
Besides utilizing the step-up in basis, there are several other tax-efficient strategies that can be included as part of a robust estate plan:
- Gifting Assets:Transferring ownership of certain high-value or appreciated property during one’s lifetime may reduce future estate taxes and provide immediate financial support to loved ones.
- I.R.A.s and Retirement Accounts:Designating beneficiaries for retirement accounts like I.R.A.s or 401(k)s allows these funds to pass directly outside probate proceedings while potentially providing significant income-tax deferral opportunities for heirs (Note: These accounts do not receive a stepped-up cost basis).
- Trusts: Establishing a trust can offer greater control over asset distribution, protect assets from creditors, account for special needs, and provide tax advantages for both the grantor and beneficiaries.
- Life Insurance Policies:Proceeds from life insurance policies are generally not subject to income taxes or estate taxes when paid directly to named beneficiaries. This makes them an effective tool for providing immediate financial support upon death.
Maximize Your Tax Benefits with Jones Elder Law
Considering one’s individual situation and objectives is essential when incorporating these tactics into an estate plan. Let Jones Elder Law help you.Our experiencedteam can provide tailored solutions to ensure your assets are adequately protected.
Contact us at (636) 493-3333 orclick here to get started today.
