Stepped-up Basis Revisited

With President Obama’s recent proposal to eliminate the stepped-up tax basis at death, I thought it would be a good time to review the benefit individuals currently receive in this regard.  While determining tax basis can get very complicated, the original tax basis of an asset is, generally speaking, its cost.  For example, if you purchase a parcel of raw land for $10,000, your original tax basis is $10,000.  If you subsequently sell the land for $300,000, your taxable gain is the difference between your tax basis and the sales price, or $290,000.  If, instead of selling the land, you give it to someone else during your lifetime, the general rule is that your income tax basis “carries over” to the recipient.  This is known as carry-over basis.  If they then sell for $300,000 they will likewise have $290,000 of gain.However, under current law, if you wait until your death to give the land away, the potential gain or loss on the sale of the property is eliminated and the estate or heirs take the property with a new income tax basis equal to the fair market value of the property.  The fair market value is generally determined as of the date of death.  Therefore, if you pass the property described above to your heirs at your death and the fair market value is $300,000, the new tax basis is $300,000.  If the property is then sold for $300,000 there is no taxable gain - a potentially significant tax savings!  The chart below shows what the federal tax savings alone might be:

Carry Over Basis Stepped-up Basis
Sale Price $300,000.00 $300,000.00
Basis ($10,000.00) ($300,000.00)
Gain $290,000.00 $0.00
Tax (23.8%) $69,020.00 $0.00

 Given the current climate in Washington I doubt that the President’s proposal will be successful in the short term, but such a change would be dramatic and not just for the super wealthy.  In the meantime, as we have discussed in a prior newsletter article, make sure your estate planning is kept up to date to take full advantage of this tax benefit.