What is a “Step-Up In Basis”

Often used in real estate or personal property planning, a step-up in basis is the readjustment of the value of an appreciated asset for tax purposes upon inheritance. With a step-up in basis, the value of the asset is determined to be the higher market value of the asset at the time of inheritance, not the value at which the original party purchased the asset.

Concept Illustration:  ‘Step-Up In Basis’

In most cases, when an asset is passed on to a beneficiary, its value is more than what it was when the original owner acquired it.  The asset therefore receives a step-up in basis so that the beneficiary’s capital gains tax is minimized – because it is not based on the increase in value from the original purchase price.  For example, say your father purchased a farm at $200,000 in 2006 and he left it to you upon his death, at which time the property had a market price of $1,000,000.  For tax purposes, the property would receive a step-up in basis, meaning your cost basis for the farm would become the current market price of $1,000,000.  So, any capital gains tax you pay in the future will be based on the $1,000,000, not on the original purchase price of $200,000.

But what if your father had first purchased his initial farm back in 1990 for $50,000.  When he sold the first farm that he owned in 2006, he realized a gain of $150,000 in value that he rolled into the second farm with a §1031 Exchange.  With the sale of the first property the capital gains taxes were deferred into the purchase of the second farm.  When, at the father’s passing, the property was transferred to the son.  The son receives the property with a “step-up” in cost basis as a non-taxable event without regard to any of the prior capital gain including the tax deferral on the sale of the first farm.

This illustration brings attention to the potential of good tax and estate planning to delay or avoid a significant tax burden.

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