Houser Firm

How to leave property to your heirs without a huge tax bill

On Behalf of | May 19, 2023 | Estate Planning, Taxation Planning

The goal of every parent is to bless their children with an inheritance that they can use long after they have passed away. Whether that be real estate such as a family home or vacation property, or an investment portfolio, these are assets you want to leave to your heirs. Normally, when you go to sell an item that has appreciated in value since you purchased it, you are required to pay a portion of that increase in value through a capital gains tax.

However, something different happens when you pass on that property through inheritance. Instead of falling under the capital gains tax, this property goes through the estate of the decedent, and the increase in value would not be accompanied by a tax due to the step-up in basis.

Step-up Basis: The simple way to transfer assets with minimal costs

A step-up basis is a tool that many people use to avoid costly capital gains taxes when the asset they want to transfer property that has been held for a long time and acquired a significant increase in value. It does not require anything more than a will in order to accomplish it.

The way it works is simple. When a person dies and the property they owned is to be willed to their heir, rather than applying the capital gains tax, the value of the property is reset at its current value, and it can be transferred to the heir without any capital gains tax.

How exactly does the step-up in basis work?

This can be understood fairly simply through an example. If you bought a house in 1985 for $100,000, and today it would be valued at $500,000, you can avoid paying the capital gains tax for the $400,000 by leaving the house to your heir.

This can provide the heirs with significant benefits beyond simply avoiding the capital gains tax. If your heir does not wish to keep the property and would rather liquidate it, the step-up in basis allows them to sell it themselves and they would only pay the capital gains on the value increase since they took ownership of the property.

What types of assets can utilize a step-up in basis?

While the most common type of asset that many people will be considering will be real estate, such as the family home or a vacation property, the step-up in basis can apply to many other types of property. Most kinds of personal property, such as antiques, family heirlooms, and other such small times fall under the step-up basis. Intangible property such as bonds, stock portfolios and bank accounts also are included. Even ownership interests in a business would benefit from a step-up in basis.

There are also some property that do not qualify for a step-up in basis. Any property that is gifted prior to the decedent’s passing does not qualify for a step-up in basis, because it is not passing through the estate. Additionally, certain retirement and investment benefits such as 401(k)s, IRAs, employer pensions or retirement plans and annuities also do not qualify for a step-up in basis. These assets will be treated differently and no step-up in basis will apply.