Step-up in basis

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A special provision of the U.S. tax code, known as step-up in basis, [1] [2] applies to appreciated taxable assets at death. [note 1] In most instances, a property's tax basis is stepped-up to fair market value at the time of the decedent's death, or, alternately, at a valuation date six months later. [3] Step-up in basis can differ, however, depending on how the property is titled.

Property titling and step-up in basis

The actual tax basis of stepped-up property will differ depending on how the property is titled.

Sole property

For sole ownership and sole or separate property [note 2] held in a revocable trust the death of the asset owner results in the asset's stepping-up in value.

Joint tenancy

For assets held in joint tenancy, stepped-up valuation applies only to the deceased partner's share of the property.

Community property

Community property steps up whenever a spousal partner dies.

Step-down valuation

If a decedent's adjusted basis in property is higher than the fair market value, the beneficiary's basis will equal the fair market value of the property at the time the decedent dies. [note 4]

Notes

  1. Not all assets qualify for stepped-up valuation. Retirement accounts, annuities, and savings bonds are some of the more commonly held accounts and assets that the IRS considers income in respect of a decedent and does not step-up in value after the owner dies. See Income in respect of a decedent for additional information.
  2. In community property states, separate property is property owned and controlled entirely by one spouse in a marriage. At divorce, separate property is not divided under the state's property division laws, but is kept by the spouse who owns it. Separate property includes all property that a spouse obtained before marriage, through inheritance, or as a gift. It also includes any property that is traceable to separate property, and any property that the spouses agree is separate property. - from Nolo dictionary of legal terms, separate property
  3. Although joint ownership allows a spouse to inherit assets without probate, the surviving spouse now holds the property as a sole owner. At this juncture, using a revocable living trust or payable on death accounts is often recommended for asset ownership rather than joint tenancy with non-spousal partners. The potential problems associated with these joint tenancies include:
    1. The joint ownership means giving away part ownership of the property. The new owner can sell or mortgage his or her share -- or lose it in a lawsuit or divorce.
    2. You may have to file a gift tax return.
    3. The joint owner inherits all of the property after death; this may not be what the owner of the property intends.
  4. In addition to step-down valuation, it should also be noted that capital losses and carry over losses must be deducted on a decedent's final tax return and cannot be carried over in the following years. See Publication 544, Sales and Other Dispositions of Assets, IRS

References

  1. Is the money received from the sale of inherited property considered taxable income?, IRS
  2. 26 USC § 1014 - Basis of property acquired from a decedent, Legal Information Institute, Cornell University Law School
  3. 26 USC § 2032 - Alternate valuation, Legal Information Institute, Cornell University Law School