A step-up in taxes refers to the step-up basis rules for estate tax. If you inherit a piece of property from a relative or friend and step-up rules apply, then when you sell that property, its value is the value listed at the time of inheritance (the date of the death). If there's no step-up basis, the value is what the original owner paid for the property.
Federal Estate Tax Law
In 2010, there was no estate tax. The executor of the estate could make a decision either to use the 2011 estate tax rules or those of 2010 if the death occurred in 2010. The rules for 2011 required the payment of estate tax on estates valued over $5 million. However, it allowed for a step-up basis if the executor chose that option. For those with smaller estates under $5 million, this was a good choice if the estate contained highly appreciated assets such as stock purchased for $1 a share now valued at $80 a share.
Benefits of Step-up
Heirs of appreciated assets often profit from a step-up if the estate is too small to pay estate taxes. For example, Uncle Bill has 100 shares of stock that appreciated from $1 to $80 per share on the day he dies. The step-up reset the basis to $80 per share. The basis is the cost used as the purchase price when calculating taxable capital gain and the value of the estate. It increases the estate, but if its value is below the exemption amount of $5 million, it doesn't trigger any estate tax. It does give a benefit to the beneficiary by resetting the basis to what is was at the date of death, in this case, $80. If the beneficiary sold the stock for that price with the stepped-up basis, he'd owe no capital gains tax. However, if there were no step-up, the original $1 per share would be the basis, and he'd have a taxable gain of $7,900.
When Doesn't Step-up Help?
A step-up increases the value of the estate if assets appreciate, which causes an increase in estate tax. The reverse is also true if assets depreciate. For larger estates, a step-up may increase the value enough that it triggers or dramatically increases the amount of estate tax to pay.
When you donate stock to charity, you can deduct the actual value of the stock from your taxes. If you purchased 100 shares of a stock for $1 and it split several times, giving you 800 shares valued at $10 each, if you donate those shares, you'd get a tax deduction of $8,000; but if you sell the shares in order to make the donation, you'd pay taxes on $7,900. You must hold the stock over a year to get the benefit of avoiding capital gains. While most step-ups refer to estate tax, charitable giving is also a form of step-up basis.
Even though there's unified credit for both gifting and estate tax, your recipient of the gift does not receive a step-up basis on the gift. If you gift $10,000 worth of stock that originally cost you $2,000, your recipient would pay capital gains tax on $8,000 when he sells it if the value didn't change. However, if you left it to him in your estate and died when the value was $10,000, if your heir sold the stock for $10,000, he'd pay no capital gains tax.
- Tax Trusts and Estates Law Monitor; Additional Analysis to Be Made When Gifting in 2011 and 2012; Samuel Weiner; February 2011
- The T. Rowe Price Program for Charitable Giving: Donating Appreciated Assets
- Napier & Company, LLC: Charitable Donations of Appreciated Stock
- Weiss & Weissman, Inc.: Step-up in Basis
- Trusts & Estates; 2011 Tax Law Changes; Donald H. Kelley; January 2011
- Photo Credit Creatas/Creatas/Getty Images
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