A step-up in basis can help you save a lot of money at the time of taxation. The term refers to income tax and capital gains and can save you a lot of money if you decide to sell an asset or property that you have inherited.
When you receive property by will or by inheritance, the Internal Revenue Service (IRS) assesses the taxes by assigning a value to the property based on its current market value, called a basis. In this article, find out how a step-up in basis can help reduce any income or capital gains taxes you might have when selling inherited properties.
Set-up in Basis
The IRS defines the basis as the value of a property used for tax purposes. When you legally inherit a property, you may need to pay inheritance tax; depending on the state you live in, Capital gains or income taxes are only triggered if you sell the property after it is inherited.
For inherited property, income and capital gains tax is calculated based on the property's fair market value, including the cost of improvements to capital assets. You will pay tax for the difference between the sale price and your basis when you sell the property. If the property has lost its fair market value when you sell it, you will have suffered a loss of capital.
Step-up in basis can be applied for all inherited assets: stocks, bonds, real estate, or any other valuable asset.
Your basis on inherited property is not what the deceased originally paid for the property. It is automatically "increased" to the asset's current market value at the time of death, which makes a big difference if the value has increased significantly.
Inherited Property and taxes
Capital gains are classified as short or long-term. If you sell the property within a year of buying, this is a short-term gain and is taxable as normal income.
If you've owned a home for more than a year, you can pay up to 15% tax if you earn between $80,000 and $441,450 (single) or $ 496,600 (joint). If you earn more than any of the maximum limits, you can pay up to 20% in capital gains. But if you make less than $80,000 a year, you're unlikely to pay capital gains tax on the property.
The sales tax exclusion rule applies if you occupy the inherited house. If you inherit a property and live in it for at least two years before selling it and you are single, you can exclude capital gains up to $250,000 without paying tax.
If you are married and file a joint return, you can exclude the home for income up to $500,000 without paying tax. To obtain the exclusion, you must use it as your primary residence.
Along with step-up in basis on your inherited real estate gain, which reduced your profit to $50,000, you are not required to pay capital gains tax while living on the property for at least two years.
A step-up in Basis Reduces Taxes.
Here's an example: your mother had a long life and recently passed away. In her will, she left her house for you. She paid $50,000 for the house 30 years ago. You don't want to live in the house or have a rental problem, so you put it up for sale.
You can use the step-up basis tax rate and capital gains to reduce inherited tax obligations.
Assuming you sell the house a month later for $400,000. Under standard tax rules, you will have to pay income tax for the positive difference of $350,000 with no basis increase if you earned less than $80,000 in that year. Using the step-up basis value of $350,000, you only made $50,000 on the house; and considerably reduced your tax burden.
This is how a step-up basis offers tax benefits - it can reduce the amount of taxes you have to pay on inherited property. It is also possible to reduce the value you owe to zero.
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