With the presidential election right around the corner there has been some news recently about the candidates’ positions on the estate tax. Less attention has been spent on an issue that could affect many more people: the stepped-up basis rules. A recent article I read stated: “Surprisingly, both Mrs. Clinton and Mr. Trump agree on doing away with the step-up in basis for inherited assets. However, they may differ on the timing of the realization of gain (Clinton at death; Trump possibly at a future disposition).” 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.
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!
With the current estate tax exemption at $5.45 million per person, few will ever be required to pay estate taxes, but everyone who inherits appreciated property will feel the impact of a change in the basis rules. Pay attention to this one, as Mr. Trump might say, it is “HUGE.”