Search
Close this search box.

Table of Contents

Step-Up in Basis

Definition

Step-Up in Basis is a tax concept that adjusts the value of an asset when it is passed on due to inheritance. The term refers to the readjustment of the value or ‘basis’ of the asset to its current market value at the time of the owner’s death, rather than its original purchase price. This adjustment can potentially reduce capital gains tax owed by the inheritor when they later sell the asset.

Phonetic

The phonetics for the keyword “Step-Up in Basis” is /stɛp ʌp ɪn ˈbeɪsɪs/.

Key Takeaways

  1. Removes Capital Gain: The “Step-Up in Basis” refers to the readjustment of the value of an appreciated asset for tax purposes upon inheritance. The higher market value of the asset at the time of inheritance is considered for tax purposes instead of the original purchase cost. This eliminates any capital gains that would have otherwise occurred.
  2. Tax Savings: It can result in significant tax savings for the inheritor. When the asset is sold, the tax is due only on the gain since the decedent’s death – not since the decedent’s original purchase. This step-up in basis rule can save inheritors a lot of money in capital gains tax.
  3. Applicability: This principle applies to property passed to a beneficiary in a will, but may not apply to all property inherited by other means or in other circumstances, such as retirement accounts. Also, it mostly benefits those in higher income tax brackets and those who inherit highly appreciated property.

Importance

The term “Step-Up in Basis” is vital in business and finance as it’s linked directly to taxation and could significantly impact the tax obligations of an individual who inherits an asset. A “step-up” in basis readjusts the value of an inherited asset for tax purposes based upon its market value at the time of the owner’s death, not the asset’s original purchase price. This adjustment can significantly reduce capital gains tax owed by the heir if they sell the asset because capital gain or loss is determined by the difference between the asset’s sales price and the seller’s basis (which is now stepped-up). Therefore, understanding of the “Step-Up in Basis” may lead to significant potential tax savings.

Explanation

Step-Up in Basis is a key instrument used to minimize the potential tax liabilities linked to the increase in value of an asset, over the period it was held by an individual prior to being transferred. Essentially, it adjusts the value, or ‘basis’ , of an asset for tax purposes upon the transfer to a new owner, commonly due to inheritance. The purpose of this step-up is to reflect market appreciation and avoid the tremendous tax burden that would occur if the asset were treated as though no value increase had occurred.For instance, if an individual inherits property that has appreciated considerably over the years, taxing it on the basis of the original purchase price would result in a long-term capital gain that could be extremely high, thereby leading to a hefty tax imposition. Here, step-up basis becomes vital, as it readjusts the value of the assets for the beneficiary, basing it off the market value at the time of the original owner’s death. This effectively reduces the amount of tax the beneficiary will be liable for when they decide to sell the asset.

Examples

1. Inheritance of Property: One of the most common examples of step-up in basis is in the case of inherited property. Imagine a person ‘A’ bought a house for $100,000 (his cost basis). At the time of his death, the market value of the house is $200,000, which becomes the new cost basis for the heir ‘B’. This means ‘B’ has a step-up in basis from $100,000 to $200,000. If ‘B’ sells the house for $250,000, he would only be liable to pay capital gains tax on $50,000 instead of $150,000, thanks to the step-up in basis.2. Stock Investments: Another example could be with stocks. If a woman buys 100 shares at $10 each, her basis in the stock investment is $1,000. If she holds onto the stock for several years and the value of each share rises to $20 by the time of her death, the basis is stepped up to $2,000 for her heir who inherits the stocks. In this case, the step-up in basis could help the heirs avoid a $1,000 capital gain when they sell the stocks.3. Gifted Assets: This case happens when a person receives a gift where the market value of the gift is higher at the time of receiving than it was when the original owner purchased it. If person ‘X’ purchased a piece of art for $1,500 and gifted it to person ‘Y’ when its market value was $4,000, person ‘Y’ receives a step-up in basis to $4,000. If person ‘Y’ sells the art piece for $6,000, he will only be liable to pay capital gains tax on $2,000. It’s important to note that tax laws are complex and can change, and the above examples should be used only for a general understanding. For advice on specific cases, it’s recommended that a tax professional or a financial advisor be consulted.

Frequently Asked Questions(FAQ)

What is a Step-Up in Basis?

A step-up in basis adjusts the value of an asset when it is passed on to an heir following death. The value is generally increased to the market value at the time of transfer, potentially reducing the heir’s tax on a future sale of the asset.

How does a Step-Up in Basis work?

When an asset is inherited, the value of the asset receives a step-up in basis, meaning the basis is readjusted to its fair market value at the time of the inheritance. If the asset is later sold, the taxable gain would be calculated based on this stepped-up basis, not the original purchase price.

Why is a Step-Up in Basis important?

A step-up in basis can be important because it can significantly reduce the capital gains tax owed when the inherited asset is later sold.

Does every inherited asset get a Step-Up in Basis?

The majority of inherited assets obtain a step-up in basis. However, nuances exist. For example, beneficiaries of inherited retirement accounts like IRAs do not receive a step-up in basis.

Can a Step-Up in Basis apply to real estate?

The step-up in basis rule can also apply to inherited real estate. The basis is adjusted to the fair market value at the time of the owner’s death, which means it can help to reduce capital gains if the property is sold.

How is the new stepped-up basis calculated?

The new stepped-up basis is typically calculated using the fair market value of the asset at the time of the current owner’s death.

What’s the difference between cost basis and stepped-up basis?

Cost basis is the original value of an asset for tax purposes, typically the purchase price, adjusted for stock splits, dividends, and return of capital distributions. A stepped-up basis refers to the readjustment of the value of an asset to its current market value when it’s inherited after the owner’s demise.

Related Finance Terms

  • Capital Gains Tax: Tax on the profit from the sale of an asset, usually investments like stocks or real estate. This tax is often impacted by a step-up in basis.
  • Cost Basis: The original value or cost of an asset for tax purposes, which is used to determine capital gains or losses. The cost basis ‘steps up’ to the market value upon inheritance.
  • Inheritance: The act of passing on assets upon one’s death. A step-up in basis typically occurs when assets are inherited.
  • Asset Appreciation: This refers to the increase in the value of an asset over time. A step-up in basis can reduce the capital gain that is linked to the appreciation of an asset.
  • Estate Tax: This is a tax on an estate or the total value of money and property that an individual has left behind after their death. A step-up in basis can affect the overall value of the estate and hence, the amount of estate tax that is due.

Sources for More Information

About Our Editorial Process

At Due, we are dedicated to providing simple money and retirement advice that can make a big impact in your life. Our team closely follows market shifts and deeply understands how to build REAL wealth. All of our articles undergo thorough editing and review by financial experts, ensuring you get reliable and credible money advice.

We partner with leading publications, such as Nasdaq, The Globe and Mail, Entrepreneur, and more, to provide insights on retirement, current markets, and more.

We also host a financial glossary of over 7000 money/investing terms to help you learn more about how to take control of your finances.

View our editorial process

About Our Journalists

Our journalists are not just trusted, certified financial advisers. They are experienced and leading influencers in the financial realm, trusted by millions to provide advice about money. We handpick the best of the best, so you get advice from real experts. Our goal is to educate and inform, NOT to be a ‘stock-picker’ or ‘market-caller.’ 

Why listen to what we have to say?

While Due does not know how to predict the market in the short-term, our team of experts DOES know how you can make smart financial decisions to plan for retirement in the long-term.

View our expert review board

About Due

Due makes it easier to retire on your terms. We give you a realistic view on exactly where you’re at financially so when you retire you know how much money you’ll get each month. Get started today.

Due Fact-Checking Standards and Processes

To ensure we’re putting out the highest content standards, we sought out the help of certified financial experts and accredited individuals to verify our advice. We also rely on them for the most up to date information and data to make sure our in-depth research has the facts right, for today… Not yesterday. Our financial expert review board allows our readers to not only trust the information they are reading but to act on it as well. Most of our authors are CFP (Certified Financial Planners) or CRPC (Chartered Retirement Planning Counselor) certified and all have college degrees. Learn more about annuities, retirement advice and take the correct steps towards financial freedom and knowing exactly where you stand today. Learn everything about our top-notch financial expert reviews below… Learn More