Recently, the Biden administration was considering repealing a long time tax benefit that affects your estate plan – the so-called “step-up in basis.” Fortunately, there is no mention of repealing this benefit in the newest Biden tax plan. The step-up in basis is one of the most powerful ways to save on capital gains tax. The capital gains tax is triggered when the holder of an asset sells the asset and realizes a profit on the sale. However, the step-up in basis occurs if an asset is included in your estate when you pass away – and completely wipes out all the built-in gain over the years.
The simplest example would be purchasing a house 20 years ago for $250,000 and selling the house today for $1,000,000. The built in gain on the house is $750,000. The federal government requires that you pay taxes on the gain amount when you sell. What if you want to pass down your home to your children? Should you sell the house? Or gift them your home? Most of the time, the answer is NO. Enter the magic of the step-up in basis!
Simply put, the step-up in basis allows individuals who inherited property to “reset” the value of the inherited asset with respect to capital gains.
Example of the Step-Up in Basis
To illustrate the step-up in basis, let’s go back to the example of the house you purchased 20 years ago for $250,000. You want the house to go to your only child when you pass away. After you pass—many years down the line—your house gets passed to your child. The fair market value of the house when you pass away is $1,000,000 which would ordinarily result in a gain of $750,000. However, the step-up in basis resets the value of the home to the fair market value at the date of death – $1,000,000. That $750,000 in gain has been completely wiped away. If not for the step-up in basis, the person inheriting the house would pay capital gains taxes on $750,000.
There is more good news! The step-up in basis applies to any “capital asset” – including stocks, bonds, art, and even cars. So the same benefit would apply for that Amazon stock you bought 20 years ago or that 1961 Ferrari you keep in the garage.
Current Capital Gains Tax Rates
The rate you’ll pay in capital gains after selling an asset depends on your current income tax bracket. The long-term capital gains tax rate for taxpayers making more than $40,400 but less than $445,850 is 15 percent, while the rate is 20 percent for individuals making more than that. Washington state recently passed a capital gains tax of 7 percent that goes into effect on Jan. 1, 2022, but real estate is exempt.
By effectively using the step-up in basis, the taxpayer in the example above would likely save $112,500! ($750,000 x 15%)
Speak With a Knowledgeable Estate Planning Attorney Today
The step-up in basis, while powerful and effective, needs to be weighed against other salient estate planning considerations. To ensure your goals are met, speak with the experienced and knowledgeable team at Harbor Law Firm. Schedule your free consultation today by calling (888) 335-2815 or filling out a form on our website.
