Taxes are a huge concern for many people when creating an estate plan. Fortunately, there are numerous estate planning tools and strategies that can help reduce, or even avoid, hefty tax obligations for you, your estate, and even your beneficiaries. One thing that can impact tax planning is the “basis” of real property. With that in mind, the Phoenix estate planning lawyers at Morris Hall PLLC explain how basis impacts tax planning within your estate plan.
What Is “Basis?”
We have all heard a lot about implemented and proposed tax changes in recent years. Some of those involved making changes to how the “basis” in property is determined. Basis refers to the value of a piece of property when determining if/how the property is taxed. When the value of a property increases or decreases the basis changes accordingly. The most common example of how basis is used for tax purposes is calculating capital gains taxes. Although there are several exceptions and loopholes to the general rule, capital gains taxes are paid when you sell an asset for more than what you paid for it. Imagine that you purchased a vacation home ten years ago for $500,000 and recently sold the home for $800,000. You realized a “capital gain” of $300,000 on the sale. Therefore, capital gains taxes would be owed on that $300,000 profit.
What Is a “Stepped-Up” Basis?
The concept behind a “stepped-up” basis is something that is important to understand because it is frequently applied when estate planning. In short, a “stepped-up” basis allows a beneficiary to use the value of an asset at the time it was passed down instead of using the donor’s original basis. In other words, the basis is “stepped-up” to the value at the time of death of the donor. For example, assume that you owned that vacation home at the time of your death. You paid $500,000 for it ten years ago but it was worth $800,000 at the time of your death. If you gifted the house to your adult child who then sold the house, capital gains taxes would be owed on the $300,000 gain using a traditional basis, making the gift considerably less valuable. Using a stepped-up basis, however, your child’s basis in the property becomes $800,000, meaning if he/she turns around and sells the house for its current value of $800,000, no capital gains taxes are due on the sale.
Stepped-Up Basis and Jointly Owned Property
Calculating the potential tax implications of jointly owned property becomes more complex. In most states, the default method is to treat jointly owned assets as “separate property” for tax purposes. As such, the amount that is included in a decedent’s estate is only 50 percent of the assets’ value, meaning only 50 percent of the value of the property will be eligible for a “step-up” in basis. The remaining 50 percent, (the surviving spouse’s half) keeps the original basis. By way of illustration, using the $500,000 vacation property example, assume that you own that jointly with your spouse and you live in a separate property state. If your spouse passes away, his/her 50 percent will get a step-up in basis to the current value of $800,000, meaning his/her original basis of $250,000 (half of the original basis) will be increased to $400,000 (half of the stepped-up basis). Your basis, however, remains at $250,000. The combined basis in the property is now $650,000 for the $800,000 property, subjecting the property to capital gains taxes on the $150,000 gain if sold. (Note that in the handful of community property states the entire property receives a step-up in basis upon the death of one owner).
Contact Phoenix Estate Planning Lawyers
If you have additional questions or concerns about how basis impacts tax planning within your estate plan, contact the experienced Phoenix estate planning lawyers at Morris Hall PLLC by calling 888-222-1328 to schedule your free consultation today.
This blog should be used for informational purposes only. It does not create an attorney-client relationship with any reader and should not be construed as legal advice. If you need legal advice, please contact an attorney in your community who can assess the specifics of your situation.
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