Stepping Up Basis to Avoid Capital Gains is Good Planning
Clients frequently come into our office with the goal of minimizing taxes upon their death. Most believe they are facing significant gift or estate taxes. Unless you are incredibly wealthy, the current unified estate and gift tax credits eliminate that risk. However, that does not mean the client should not be planning for taxes, just not the ones they anticipated. For the average client, the taxes they will be exposed to are Capital Gains and Income Taxes on their retirement accounts and annuities. With proper planning you should be able to achieve a step up in basis on your appreciated assets to eliminate capital gains exposure. Step up in basis is an important tool to maximize the wealth you are able to transfer to your beneficiaries. Part of any competent estate and elder law plan would be how to use the step up in basis to minimize capital gains tax exposure.
Source of Capital Gains
So where does capital gains tax exposure come from? When an asset is inherited upon the death of its original owner, it is often worth more than when it was originally purchased. See https://www.fool.com/millionacres/taxes/articles/what-step-basis/. The most common source of capital gains come from investments that have appreciated in value over a long period of time. For example, assume that your mother was an employee of Apple and purchased their stock when it was first issued. She may have purchased that stock for $5,000 and then just held onto it throughout her career. Many years later that stock is now worth $350,000. If she were to sell that stock, she would have a capital gain of $345,000 or the difference between the sales price and the basis she had in the stock. That gain would be subject to long term capital gains tax. Based upon her taxable income, she could be subjected to a long-term capital gains tax rate of 0%, 15% or 20%. So, in a worst-case scenario, your mother would pay a long-term capital gains tax of $69,000. However, if your mother left the Apple Stock to you using proper estate planning, that stock would receive a basis adjustment to the fair market value of the stock on the date of your mother’s death. So rather than having a basis of $5,000, you now own the stock and your basis would be $350,000. This adjustment of the basis on the date of her death is referred to as the step up in basis. Now that your basis is the same as the fair market value, if you were to sell the appreciated Apple Stock you would not owe any long-term capital gains tax.
Step Up in Basis
Section 1014 of the Internal Revenue Code is the source of the step up in basis available on death. In pertinent part it provides that the basis of property acquired from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be the fair market value of the property at the date of the decedent’s death. See https://www.law.cornell.edu/uscode/text/26/1014. This section of the Internal Revenue Code is your ticket to pass appreciated assets to your loved ones and avoid paying capital gains taxes on the increase in the assets value. The most common asset this will apply to is the family home that has increased in value since the original purchase date. In our practice we frequently encounter clients who purchase there home twenty (20) plus years ago and have seen that property increase significantly in value. However, many other assets such as stocks, vacation homes, farm ground, hunting ground etc., can also take advantage of the step up in basis provisions to minimize capital gains exposure.
Beware of Lifetime Gifting and Capital Gains
In our elder law practice clients will frequently pose the idea that they should simply give their assets to their children while they are alive to protect them from long term care. Without discussing the issues of such gifting on long term care risks, it is important to understand that lifetime gifting has significant tax implications for appreciated property. If you make an outright gift of your appreciated property to your children, they will NOT be eligible for a step up in basis on that property. See a Journal of Accountancy article noting, “[a]void gifting highly appreciated property so that clients and their families can lock in the step-up adjustment at death. https://www.journalofaccountancy.com/issues/2019/may/basis-consistency-requirements-appraisal.html” So in the example above, if you were given the Apple Stock prior to your mother passing, you would not receive the step up in basis and you would owe the $69,000 in capital gains tax upon the sale of the stock. This is why proper estate and elder law planning is so important. Using the proper trust, the client can have their cake and eat it too. The proper trust should get the assets out of the client’s name to protect them from long term care while still achieving a step up in basis for their intended beneficiaries. The client is able to reduce the risk associated with long-term care and eliminate the capital gains associated with their lifetime appreciation.
Educate Yourself with a Vision Meeting
If you or your family are struggling with any Estate Planning or Probate concerns, make an appointment with the experienced St. Charles Estate Planning Attorneys at Jones Elder Law. That way, you can decide what happens to the assets you worked so hard to acquire. If we can help guide you, contact our St. Charles Estate Planning Law Firm at (636) 812-2575 and ask to schedule a call or virtual consultation, what we call a Vision Meeting http://joneselderlaw.com/vision-meeting/. For your safety and ours we have developed the Minimal Contact Planning process to be used while the Covid-19 virus remains a concern.
