Stepped-Up Basis

The stepped-up basis is a method to adjust the valuation of property inherited from a decedent to its fair market value as of the date of the decedent's death.
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Stepped-Up Basis

Definition

The stepped-up basis is a process by which a person’s tax basis in an inherited asset is adjusted to its fair market value (FMV) as of the date of the decedent’s death. This method is predominantly used to determine tax obligations when the asset is sold by the heir. Essentially, the capital gains tax is minimized because the cost basis of the asset is “stepped up” to the market value at the date of inheritance rather than the original purchase price.

Examples

  1. Real Estate: Consider a scenario where an individual inherits a property that was purchased by the decedent for $100,000 but has a fair market value of $400,000 at the time of death. With a stepped-up basis, the tax basis is adjusted to $400,000, and if the heir sells the property for $450,000, their taxable gain will only be $50,000 ($450,000 sale price - $400,000 basis), compared to $350,000 without the stepped-up basis.

  2. Stocks: An heir inherits 100 shares of a company’s stock. The decedent originally bought the shares for $10 each ($1,000 total) but the shares are now worth $50 each ($5,000 total). The stepped-up basis would value the stock at $5,000, not the original $1,000. Thus, upon selling the shares at $55 each, the heir’s taxable gain is $500 ($5,500 sale price - $5,000 basis).

Frequently Asked Questions

What assets qualify for a stepped-up basis?

Typically, assets that qualify for a stepped-up basis include real estate, stocks, bonds, and other capital assets that are inheritable.

Are there any exceptions to the stepped-up basis rule?

Yes, some exceptions include irrevocable trusts established before the decedent’s death, certain joint tenancies, and properties in community property states where only the decedent’s half interest receives a stepped-up basis.

How is the fair market value determined?

The fair market value is generally determined by an appraisal of the property based on comparable sales, the property’s condition at the time of the owner’s death, and other relevant factors.

Can a stepped-down basis occur?

Yes, if the fair market value at the time of the decedent’s death is lower than the original purchase price, a stepped-down basis applies, adjusting the basis downward to the fair market value.

Does the stepped-up basis apply to gifts?

No, the stepped-up basis rules typically do not apply to gifts. The recipient of a gift assumes the donor’s adjusted basis in the property.

  • Tax Basis: The original value of an asset for tax purposes, usually the purchase price, adjusted for factors such as depreciation.
  • Fair Market Value (FMV): The price that an asset would sell for on the open market.
  • Capital Gains Tax: Tax on the profit made from selling an asset that has increased in value.

Online Resources

Suggested Books

  • “Estate Planning Basics” by Denis Clifford
  • “Tax Savvy for Small Business” by Frederick W. Daily
  • “The Wall Street Journal Complete Estate-Planning Guidebook” by Rachel Emma Silverman

Fundamentals of Stepped-Up Basis: Taxation Basics Quiz

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