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Understanding Step Up in Basis for Estate Planning

Step Up In Basis

The recent passage of the 2017 Tax Cuts and Jobs Act which raised the federal estate tax exemption to approximately $11 million dollars for an individual ($22,000 for married couples). Despite some speculation to the contrary, the “step up in basis” on inherited assets, was preserved and this opened up an opportunity for certain individuals to take advantage of a frequently overlooked and potentially valuable tax savings device.

Estate Planning Changes for New Estate Tax Updates

In years past, the aim of typical estate planning was directed towards removing assets from your estate in order to avoid and/or minimize estate taxes.  Under current law, with such a generous exemption, fewer estates will exceed the federal estate tax exemption. This scenario now makes it sensible to include certain assets in your estate. Specifically assets which have appreciated substantially in value over the years would benefit from getting a step up upon the owner/individual’s death. The transfer through an estate would have a dramatic potentially have a win/win effect of:

i) not triggering estate tax liability (in other words assets valued under $11,000,00); and

ii) giving beneficiaries the “step-up” in basis, potentially saving huge sums in individual income taxes.

What is the Step Up in Basis for Estate Planning?

By way of background, the effect of the “step-up” in basis is that when an individual inherits property, the value of such property is calculated at the date of death of the grantor, and not the original purchase price.  This can add up to a huge savings in the case of property which has appreciated considerably over many years.  As such, if the individual then sells the inherited property, there would be no individual income tax due on the gain from any sale.  Without that “step-up” there may be a considerable tax liability upon any transfer of the same property.

The power of the step up can be demonstrated with a common example.

Let’s say, there is a vacation home that “mother” purchased forty years ago at a price of $50,000.  In the year mother passes away, the vacation home, which is included in her estate, is now worth $800,000.  Accordingly, if and when the beneficiary sells the vacation home, the basis used for her individual taxes is the date of death value of the family home; $800,000.  A subsequent sale of the vacation home for exactly $800,000 would yield zero income tax liability. Daughter pays no individual income taxes on the gain from the sale. This is in contrast to the basis rules of gifting, whereby if an asset is gifted, the basis of the asset “carries over” to the recipient.

In our simple example, had mother gifted the vacation home to the daughter five years prior to her death, then subsequently, the daughter sells the vacation home, she would have a taxable gain of $750,000 on her individual income taxes. This is because of the basis of the mother ($50,000) carries over to the daughter receiving the gift.

To recap this scenario in quick math: gifting home = income taxes on $750,000 of income vs. no taxes on $800,000 of income.

Applying the Step Up In Basis in Florida 

Taking the mechanics of this example to current estate planning, if your estate plan in Florida, or home state, was established under an earlier taxation scheme (i.e. when the federal exemption was $1,000,000), you very likely are not optimally using all available tools to save on both estate taxes, and the potential individual income taxes on your heirs and beneficiaries.  In sum, in the past, it was optimal to plan on keeping large assets out of the estate (to save on paying estate taxes).

Non-Florida Residents and Potential State Estate Taxes 

But with the federal estate tax exemption being so large (important note of caution: if you are not a Florida resident for homestead purposes, nor a resident of another state without estate taxes, your home state may impose its own estate tax rate. Your estate plan would still need to account for) these state estate taxes and the federal estate taxes may be less of a current concern. In this example, your estate plan should be revised specifically to include certain assets which have appreciated in value over the years.

The important takeaway is, whenever there is a significant change to either the estate taxation rates or an increase (or even decrease) in the value of your assets, it’s important to revisit your estate plan in Florida or your home state and keep it at optimum efficiency to the current tax rates.

Kevin J. Wimmer, LLM

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