Capital Gains & The Stepped-Up Basis Rule

Recently, the Weber Accetta Group has been delving deep in learning more about Capital Gains – shout-out to Grant Alley at Progressive Title Company who keeps our education on-going!

One interesting topic we covered was the “Stepped-Up Basis” Rule under Internal Revenue Code § 1014(a), which we will cover in this post. Please note that we have simplified the following example and definitions to more clearly explain the situation.

Basis” is generally the amount you have invested in an asset. For example, if you buy a house for $750,000, your “basis” is $750,000.

Gain” is the amount you receive when you sell an asset, minus your basis in the asset.

“Taxable capital-gain income” is the selling price of an asset minus the basis. For example, if you sold the house above for $800,000, your gain (which you might be taxed on) would be $50,000 (sales price of $800,000 minus your basis of $750,000).

These factors stay especially relevant in an inheritance situation. Normally, when someone receives an asset from someone before he or she dies, the person who receives the asset will keep the same basis in the asset that the donor had. So if you bought your home at $750,000 and then gifted it to your daughter prior to your death, her basis in the home would be $750,000, no matter the current market value. However, if she were to turn around and sell the home for $1,000,000, she would have to pay pay income tax on the $250,000 of capital-gain income.

Alternately, if your daughter inherited the home after your death her basis in the asset is “stepped up” to the fair market value on the date of the death. Therefore, her basis would be bumped up to $1,000,000, so if she were to sell it she would not be taxed on the gains.

Just to refresh:

Beneficiary” is the person receiving an asset

 “Benefactor” is the person giving an asset

The takeaway: a high stepped-up basis can greatly reduce the beneficiary’s taxable capital-gain income when the beneficiary sells the inherited asset.