What is “Step up in Tax Basis”? – By John R. Bullis

Kim Pilant John's Articles

A special tax benefit to save future income taxes is known as the “Step Up in Tax Basis”.

This happens when someone dies and leaves stocks, bonds, personal property and real estate to the heirs.

For example, suppose Joe bought a stock for $ 1,000 years ago and still has it when he dies. If the fair market value of that stock at death is $11,000, the tax basis in the hands of the heirs is $11,000.

Then if the heirs sell the stock, they can receive $11,000 tax free. The tax basis of that stock is increased from Joe’s cost of $ 1,000 to the value at death of $11,000. If the heirs sold the stock for $ 11,500, they would only have a $ 500 long term capital gain. (all items inherited are given long term capital gain holding period, even if they sold the stock just a month after inheriting it).

If the heirs sold the inherited stock above for $ 10,500, they would have a deductible $ 500 long term capital loss.

The new tax law continues to have the “step up” in tax basis for most assets inherited. IRA accounts and annuities do not get a step up in tax basis. The heir will report and pay tax on the taxable part of distributions from those items.

For example if the annuity was purchased for $10,000 before the death and is worth $15,000 at death, the $5,000 increase (from earnings) will be taxable income to the heir when the annuity is cashed in. If payments are spread out over a few years, then a prorata part of the payments is taxable income and part is not taxable as a return of part of the original investment.

Unless the IRA account includes some contributions that were not deductible, the distributions from the IRA are taxable income to the heir.

You can see the difference between original cost of a stock and the value at death is not ever taxed. Don’t tell Congress about this benefit or they may change it.

In a community property state like Nevada, when one spouse dies, the value of the community property is increased to the total value for the surviving spouse. That is a special benefit of community property and does not apply in most other states.

On the other hand, life insurance death benefits are not taxable. Usually the payment from the life insurance company includes a very small amount of taxable interest. That interest is taxable income for the heir.

Did you hear “Embrace the new, no matter how uncomfortable and make it work for you.” Alex Smith