Changes in Stepped-Up Tax Basis

April 13, 2006

	Visited: 164

	1.0/5.0 (1 votes total)
	Rate:

The estate tax reform of 2001 made significant changes to the tax basis of gift or inheritance assets when they are later sold.

The recipient of gifts given during a donor's lifetime also receives the carryover tax basis of the gifts. In short, all capital gains for those assets accumulated during the donor's lifetime are carried over to the recipient, and when this person later sells the assets, capital gains taxes must be paid by the recipient on the entire appreciation in value of the assets. So in this case, estate tax avoidance can result in substantial capital gains taxes for the recipient.

On the other hand, assets left in the estate and exposed to estate taxation--even if no tax is due because of the allowable estate exemption--are given a stepped-up basis for the recipient, usually equal to fair market value. In short, when the recipient later sells the assets, capital gains taxes are only assessed on the difference between the stepped-up basis and the ultimate selling price. But this situation is not permanent.

To further complicate matters, when the estate tax is fully repealed (which is for year 2010 only, according to current law), limits are placed on allowable stepped-up basis, presumably to keep people from taking advantage of a situation where they would pay no estate taxes and also completely avoid capital gains taxes.

Under the terms of a full estate tax repeal, only $1.3 million of inherited assets are eligible for stepped-up basis. The balance retains the carryover basis from the donor. In addition, a surviving spouse is allowed an extra $3 million in stepped-up inherited assets, bringing that total to $4.3 million. The estate's executor can decide which of the assets gets the stepped-up basis and which get the carryover basis.

Clearly, a plan for federal estate taxes involving gifting, exclusions, exemptions and changes in tax basis of assets is extremely complicated and involves carefully balancing a number of objectives. But the tax savings are potentially enormous. For this reason, it is very important to consult an expert in this field before undertaking any of these strategies.