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Step-Up and Substituted Basis

Here's a breakdown of each concept and how a step-up in basis may help heirs avoid unnecessary taxation.

Updated over 2 months ago

Understanding the differences between step-up in basis and substituted basis is crucial for effective estate planning and minimizing taxation for heirs. Here's a breakdown of each concept.

Step-Up in Basis:

  • Definition: Step-up in basis refers to the adjustment of the tax basis of inherited assets to their fair market value at the time of the owner's death. This adjustment minimizes capital gains tax when heirs sell the inherited assets because they are deemed to have acquired the assets at their new, higher basis.

  • Example: If an individual purchased a stock for $10,000, and at the time of their death, the stock's value is $50,000, the heir's basis for capital gains tax purposes would be stepped up to $50,000.

  • Residents of states with community property laws or those with assets in community property trusts qualify for a full or partial step-up in basis for the surviving spouse.

Substituted Basis:

  • Definition: Substituted basis refers to the cost basis of an asset received from another individual. A common example is an asset gifted to another individual during someone's lifetime. The original purchaser's cost basis and the substituted basis are generally the same.

  • Example: If an individual purchased real estate for $200,000, and the value at the time of the asset's gifting was $300,000, the new owner's cost basis would be $200,000. If sold, capital gains would be owed on $100,000.

    • Generally, assets that have depreciated are considered more favorable to gift during one's lifetime.


Preserving Heirs' Step-Up in Basis:

While there are many methods to reduce taxation the most commonly used method is to hold on to your appreciated assets until death.

  • Holding any applicable appreciated assets until death ensures that heirs receive a step-up in basis, minimizing capital gains taxes upon the subsequent sale of those assets.

Regularly Review and Update the Estate Plan:

Estate plans should be regularly reviewed and updated if needed to adapt to changes in tax laws and family circumstances, ensuring that the chosen strategies align with current goals. Financial advisors, tax professionals, and estate planning attorneys often work together to tailor strategies based on your individual circumstances and goals.

If a plan was created within EncorEstate Plans, that plan's advisor will be notified of any critical changes to laws and regulations that would require the client to update their Estate Plan.

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