|Step-Up in Basis
|A tax program designed to help Americans generate family wealth by allowing them to sell inherited property without having to pay capital gains tax.
|The increase in value of an asset over time. If an asset is sold for more than its original purchase price, the difference is considered a capital gain.
|Capital Gains Tax
|A tax on the profit made from selling an asset.
|Benefits of Step-Up in Basis
|It prevents over-taxing inheritors for their loved one’s property, making it easier for them to sell the property without facing a large tax bill.
Step-Up in Basis is one of the most essential tax programs for American homeowners. If you aren’t familiar with the program let’s talk about how Step-Up in Basis works and how it helps many hard-working Americans like you.
Most Americans live paycheck to paycheck, especially now with rising inflation rates. The cost of living is going up faster than ever and many of us are struggling just to pay the bills.
This might not be an easy question but it is one that needs to be asked.
If a loved one passed away and left you their property, could you afford to even sell it?
No, most people wouldn’t.
This is what Step-Up in Basis is all about. The program was originally created to help Americans generate their own family wealth. But nowadays most homeowners can’t afford an unexpected bill. So Step-Up in Basis is the only thing allowing them to at the very least, sell the property instead of having the bank seize it.
How Does Step-Up in Basis Help Me Reduce Taxes?
What Step-Up in Basis essentially does is stop over-taxing inheritors for their loved one’s property.
Any property is considered an asset, even if it is just land. Anytime someone sells an asset (such as property) for more than what they originally paid, it is considered a capital gain.
Capital gains are how much an asset gains value over time.
So for example, if you buy a comic book for $1 and you save it, make sure to keep it safe. 20 years pass and now that comic book you paid $1 for is now worth $100. That means the comic book has gained $99 in value over the time that you have had it.
This is known as long-term capital gains. Any capital gains are considered long-term if you have owned the asset (the object/property) for more than a year. Anything owned for under a year is considered short-term capital gains.
If you make capital gains on any asset you own (like a comic book) you are required to pay what is called capital gains tax.
But what if you weren’t the original owner?
This Is Where Step-up in Basis Comes In
Your grandfather bought a house years back when they first started their family. Now, all the kids have grown up and have had kids of their own. He finally passes, and you find out that he left you his house.
All those years ago he paid $50,000 for the house. Now, the real estate market values your dear Grandpa’s house at $250,000. That is a capital gain of $200,000. For a long-term capital gain, you would be looking at paying 15% – 20% in taxes which would be $30,000 – $40,000 cash.
So, the “Basis” part of Step-Up in Basis is the original $50,000 Grandpa paid for the house. When you inherit the property the worth is reevaluated at $250,000. That is quite a “Step up”, don’t you think?
And the IRS agrees. That would be a very large amount of capital gains tax to pay, especially so suddenly. That is why they allow you to “step up” the “basis or (base)” value so that no capital gains are required to be paid upon inheriting the property.
What Happens if You Want To Sell the Property Later?
Continuing to use the same example, let’s look at what would happen if you later decided to sell the property. When you inherited this piece of real estate its appraised market value was $250,000.
You decide to hold on to the property at first but eventually decide to just sell the property. A few years have passed and the real estate market has gone up. The house is now appraised at a market value of $350,000.
That is a total capital gain of $100,000 since you inherited the property. Let’s assume that your long-term capital gains tax percentage is 20% (the highest percentage possible). That means the capital gains tax you will pay is only $20,000 (AKA 20% of the $100,000).
The biggest rule of step up in basis is simple but somewhat morbid, so let’s be candid. Most assets you inherit will qualify for step-up in basis (there are only a select few that don’t qualify for Step-up in Basis). As long as the asset is inherited AFTER the owner is deceased. The key thing to remember here is ownership must change AFTER death.
People like to plan for the future, which is why we plan for what happens after we die. As some people reach old age, terminal illness, or for other reasons, they want to start the process of passing their most precious belongings and assets along to their loved ones. It is a normal part of moving on and finding peace of mind close to death.
Even with how sweet the sentiment is, this is not what should be done.
You want to avoid paying a ton of unnecessary taxes, right? If you were passing something on to a loved one, you wouldn’t want them to pay a large amount on unnecessary taxes, would you?
Gifting assets to loved ones is one way that people try and avoid large tax fees but in fact, this is one of the worst things you can do.
Using the same example from before, your grandfather bought this home for $50,000 all of those years ago. Now, as he is getting ready to pass, he decides to gift you the property. The property is appraised at $250,000 at the time of his gifting it to you.
It seems amazing at first, right? But then a few years down the road, you decide to sell the house. Now its appraised worth is $350,000.
You are still required to pay long-term capital gains tax but this time it is a little different.
This time you have to pay capital gains tax on the entire increased price of the property which is now $300,000. Stepping up the basis of the assets’ appraised value is how you could have avoided paying taxes on that extra $200,000.
So instead of paying $20,000 (AKA 20% of the $100,000) in capital gains tax, you will now pay $60,000 (AKA 20% of the $300,000).
You might think that this is just an unfair tax loophole for the super-wealthy. But in fact, this is a tax credit that EVERYONE has access to. It’s just not talked about enough. The entire point of Step-Up in Basis is to help everyone have a fighting chance to gain generational wealth.
Not paying capital gains taxes on inherited assets is an incredible way to pass wealth down from one generation to the next. If you had to pay taxes on all of the wealth your family is able to generate, there is less opportunity for Americans to grow, gain wealth, and try to prosper.