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When establishing an estate plan it is important to consider whether a particular asset has a cost basis associated with it.  There are certain types of assets that get a “stepped up” basis when the owner of these assets dies.  Not all assets receive a step up.

Why is this important? When a beneficiary receives an asset with a cost basis, the value is stepped up to the value at the time the owner dies. For example, if Joe bought a home for $100,000 in 1970, and when he dies the home is worth $200,000, the beneficiary receiving this home will assume the basis of the home at $200,000 and pay no capital gains tax. The beneficiary, now owner of the home, has a cost basis of $200,000 for the home. If the beneficiary later sells the home for $210,000, the capital gain will be calculated on $10,000 ($210,000 - $200,000), not $110,000 ($210,000-$100,000).

Many assets, including real estate, mutual funds, and stocks not in a qualified plan, receive this step-up basis at the date of death. Annuities, 401(k)s and other tax deferred qualified plans do not receive a step -up. Therefore, the beneficiaries must pay tax on the asset as ordinary income.

If Joe had given the home to his daughter as a gift during his life, the daughter’s basis would be $100,000 (the value when Joe purchased it in 1970). If daughter later sells the property for $210,000, she would have a hefty capital gains tax on the amount of the gain of $110,000.

Why is this important when creating an estate plan? Because not all assets have a cost basis, it’s important when making your distribution choices that you have considered either the basis adjustment or the lack of such adjustment.

For example, you have two daughters that you intend to treat equally after you pass away. Assume you have a $100,000 IRA and a home you bought for $50,000 in 1960 that is currently appraised at $100,000. Betty receives the IRA, and Julie receives the home. Since the IRA does not qualify for a step-up in basis, Betty will have to pay taxes on the $100,000 as ordinary income according to her tax bracket. If Betty is in the 35% tax bracket, her inherited amount will total $65,000. On the other hand, Julie sells the home immediately and receives $100,000 because the home receives a step-up in basis and pays no capital gains taxes.

What happens with assets held in a Revocable Living Trust? Assets held in a Revocable Living Trust do receive a step-up or step-down in basis upon death. Having assets held in a trust does not change the basis associated with appreciable assets with a cost basis.

It is therefore very important to recognize that the basis for the recipient of an asset with a cost basis may vary dramatically depending upon whether the asset is gifted during the donor’s lifetime or distributed to them at the owner’s death. Typically, it is best to gift assets that have a basis near fair market value while retaining assets that have a low cost basis to pass upon your death.

Wendy-Harn-PhotoContributed by Morris Hall, PLLC Tucson and Oro Valley Estate Planning Attorney and Partner, Wendy W. Harn.

About Morris Hall, PLLC:
At Morris Hall, PLLC we have focused our legal practice on estate planning for over 45 years.  Along with estate planning, our attorneys help clients and their families with matters of probate, trust administration, wills, power of attorneys, business planning, succession planning, legacy planning, charitable gifting and other important legal aspects.  We also have divisions in financial, real estate and accounting to help you incorporate all of your planning together, ensuring that everything works perfectly for your needs and situation. Our Arizona offices are located in Phoenix, Mesa, Scottsdale, Carefree, Tucson, Oro Valley, Prescott, Flagstaff and Arrowhead.  Our New Mexico offices are located in Albuquerque, Las Cruces and Santa Fe.  Contact us today at 888.222.1328 to schedule an appointment!

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.

 

 

2 Comments

  • D K says:

    MY MOTHER HAD REVOCABLE LIVING TRUST, SO THAT MY WIFE AND I COULD HANDLE HER BROKERAGE ACCT. THE ATTORNEY HAD APPLIED FOR AN EIN UPON DRAWING UP THE TRUST. I FOUND OUT LATER THAT IT WAS NOT NECESSARY,SINCE ALL THE INCOME FROM THE TRUST WAS REPORTED ON HER 1040 WITH HER SS NUMBER. UPON HER DEATH THE ASSETS WERE MOVED TO A IRREV. TRUST FOR US WITH THE SAME TRUSTEES. NOW THE BROKERAGE REFUSES TO STEP-UP THE BASIS. THEY MAKE THE EXCUSE THAT BECAUSE THE TRUST HAD A EIN THAT IT IS NOT ENTITLED TO STEPUP.
    IS THAT TRUE?

    • Morris Hall says:

      This does not sound correct. If her brokerage was reporting income to the social security number, then you would have to assume they would show her as the legal owner and there should be a DOD step-up. Even if the brokerage reported to a trust EIN, you would assume it’s a disregarded entity for tax purposes and the DOD step-up would still occur.

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