Can I build Family or Generational Wealth by taking advantage of “Stepped Up Basis?”

This is one of the most important issues for Estate Planning and Family Wealth Building. A big tax savings can be had by making a gift or transfer at death instead of during the life of the benefactor/parent.

This is most evident in gifting a greatly appreciated asset. If the transfer is made during the life of the benefactor/parent, the beneficiary/child takes the gift at the same basis (cost or investment) of the parent. That is the amount the parent paid for the asset or that amount reduced by depreciation taken by the parent.

However, if the transfer is made at the time of death of the parent, the child takes it at the fair market value as of the date of death. This is a “STEP-UP IN BASIS”.

26 U.S.C. 1014

(a) In general

Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be—

(1) the fair market value of the property at the date of the decedent’s death,

Example One:

Parent purchased a home in 1975 for $40,000 and spent $10,000 on an addition in 1995. Parent’s basis is $50,000. If gifted to the children in 2017, in a misguided effort to not pay an attorney to do proper estate planning, the child takes the gift at a $50,000 basis.

Parent died in 2022. The 2022 fair market value is $200,000. Child sells house a month after parent’s death for $200,000. $150,000 is subject to taxation via the capital gain tax.

The capital gain rate for 2021 is 15% up to $459,750, 20% for amounts over that. That results in a tax bill of $22,500. If the house had passed to child in a will, trust or even life estate deed, the tax bill would have been $0.00.

Example Two:

Parent purchased $5,000 of Tesla, Inc. stock in September of 2010. Parent gifts the stock to child in 2020. Child assumes parent’s basis.

Parent dies in July 2022. Child sells stock right away for fair market value of $1.1 million with a tax bill of almost $200,000. If the Tesla, Inc. stock had passed to child in a will, or Trust, the tax bill would have been $0.00.