Inheriting property can bring a range of emotions—from gratitude to uncertainty—especially when considering the tax implications. One of the key financial benefits often associated with inheriting property is the “step-up in basis,” which can significantly reduce the capital gains taxes owed if and when the property is sold.
But what exactly is a step-up in basis, and will you receive one on the property you’ve inherited? Let’s explore.
What is a Step-Up in Basis?
When you inherit property, the cost basis (the amount used to determine taxable gain) generally gets “stepped up” to the fair market value (FMV) at the time of the decedent’s death. This means if you sell the property, you only pay taxes on the difference between the sale price and the value at the time you inherited it—not the original purchase price. For example, if the property was purchased for $100,000 and is worth $500,000 when you inherit it, your cost basis becomes $500,000. If you later sell it for $550,000, you’ll only be taxed on the $50,000 gain.
Will You Receive a Step-Up in Basis?
Whether or not you receive a step-up in basis depends on several factors. To determine your situation, I have posted a step-by-step guide below, based on a flowchart that addresses the most common questions surrounding inherited property and step-up in basis rules.
1. Was the Property Owned Solely by the Decedent?
If the decedent was the sole owner of the property, you will likely receive a full step-up in basis to the fair market value at the date of their death.
2. Was the Property Co-Owned (Joint Tenants or Tenants in Common)?
If you co-owned the property with the decedent, your step-up in basis will vary depending on how the property was titled. In joint tenancy (JTWROS), only the decedent’s portion of the property gets the step-up in basis. In contrast, tenants in common typically allow each owner’s share to receive the step-up based on the decedent’s date of death.
3. Did You Inherit from Your Spouse?
Spouses benefit from unique step-up in basis rules. In community property states, if you inherited the property from your spouse, both halves of the property may receive a step-up in basis, as long as at least half was included in your spouse’s gross estate. In non-community property states, only the decedent’s share of the property receives the step-up.
4. Was the Property Sold Shortly After Death?
If the property was sold shortly after the decedent’s death, the step-up in basis generally reflects the fair market value on the date of death. However, if an alternate valuation date was selected (six months after the death), the step-up is based on that later date. If the property was sold before the alternate date, the sale value becomes the cost basis.
5. Does the Property Fall Under Certain Exclusions?
Certain types of property, such as IRAs, 401(k)s, annuities, pensions, and assets held in irrevocable trusts, are not eligible for a step-up in basis. In these cases, the cost basis remains the same as the decedent’s adjusted basis, and any gains are subject to tax when the assets are distributed or sold.
6. Did You or Your Spouse Gift the Property Within a Year of the Decedent’s Death?
If the property was gifted back to the decedent within a year before their death, you will not receive a step-up in basis. Instead, the property will retain the decedent’s adjusted basis, which could mean a higher tax bill when you sell the property.
Key Considerations
Understanding the step-up in basis rules is crucial for effective estate and tax planning. The rules can vary depending on the state you live in, the type of property you inherit, and the relationship you had with the decedent. For example, living in a community property state can significantly affect whether you receive a full or partial step-up in basis.
At Brooks Wealth Management, we help clients navigate the complexities of estate planning and tax implications surrounding inherited property. If you’re unsure whether your inherited property qualifies for a step-up in basis, I encourage you to reach out so we can have a personalized conversation.
Disclaimer:
The information provided in this financial planning post is intended for general informational purposes only and should not be construed as personalized financial, investment, tax, or legal advice.
Financial planning is a complex and highly individualized process that takes into account your unique financial situation, goals, and risk tolerance. While this post aims to provide useful insights and guidance, it is not a substitute for professional advice tailored to your specific circumstances. We strongly recommend that you consult with a qualified financial advisor, tax professional, or legal expert before making any financial decisions or implementing any financial strategies. Any decisions made based on the information in this post are solely at your own risk.