Stepped-up basis

Stepped-up basis is the basis of property that a taxpayer receives from a decedent under the Internal Revenue Code § 1014(a).

General rule

Under IRC § 1014(a) the general rule applied to property a beneficiary receives from a benefactor is that the beneficiary's basis equals the fair market value of the property at the time the decedent dies. For example, Decedent owns a home they originally purchased for $35,000. Their basis in the home is equal to its cost, $35,000, assuming no adjustments under IRC § 1016. On the day Decedent dies, the fair market value of the home is $200,000. If Decedent bequeaths the home to Beneficiary, Beneficiary's basis in the home will be the fair market value, $200,000. In contrast, had Decedent given the home to Beneficiary before their death, Beneficiary would receive a carryover basis, which would be equal to the decedent's adjusted basis in the home, $35,000.^[1]

Simplified Example

"Basis" is generally the amount you have invested in an asset. Thus, if you buy a house for $35,000, your "basis" is $35,000, in the very simple case.

"Gain" is generally the amount you receive when you dispose of an asset less your basis in the asset, again, in the very simple case. Thus, if you sold the house above for $100,000, your gain (what you might be taxed on) would be $65,000 (sales price of $100,000 less your basis of $35,000), if we ignore other factors for purposes of this example.

Normally, when you give an asset to someone, the person who receives the asset keeps the same basis in the asset that the donor (you) had. If you give this house to your sister Mary, after the gift, her basis in the house would also be $35,000, no matter what the fair market value (FMV) of the house was on the date of the gift. As you can see, this means that your sister is liable for the $65,000 gain if she were to sell the house at $100,000.

However, in the case of a beneficiary receiving an asset from a decedent through a bequest, the recipient's basis in the asset is "stepped up" to the FMV on the date of the death. In this case, if you had a basis in the house before your death of $35,000 but the FMV of the house was $100,000 on the date of your death, then if you bequeathed the house to your sister, her basis would be $100,000, not $35,000.

The obvious impact of this rule is that if your sister, after your death, sells the house for $100,000, then she would not have to recognize any gain on the house, because the sales price ($100,000) less her basis ($100,000) would be zero.

See the explanation under "Rationale for stepped-up basis" (below) for an explanation of why the Tax Code would do this.

Stepped-down basis

Likewise, under § 1014(a), if a decedent's adjusted basis in property is higher than the fair market value, the beneficiary's basis will equal the fair market value of the property at the time the decedent dies. For example, Decedent owns a yacht whose adjusted basis is $150,000, but at the time of her death, the fair market value of the yacht is only $110,000. The beneficiary's basis in the yacht will be the fair market value, $110,000.

Incentive for Taxpayers

Because of this provision, any appreciation of the affected property that occurred during the decedent's lifetime will never be taxed. Thus, this provision provides an incentive for taxpayers to retain appreciated property until death, and sell property that has fallen in market value while alive (although it should be noted that depreciable property may still cause a gain - even when sold for less that original purchase price, because depreciation subtracts from basis).

§ 2032 Election for Alternate Valuation

Section 2032 provides an alternate method of determining the property's new basis. If the property is not disposed of within six months of the decedent's death, the executor may elect to use the property's fair market value six months after the date of death BUT ONLY IF SUCH AN ELECTION RESULTS IN A DECREASE IN THE VALUE OF THE GROSS ESTATE.^[2] If the executor does not so elect, or if the property is disposed of before the six months have passed, then the property will still assume a basis equal to its fair market value at the time of death.

Definitions

"Property acquired from the decedent" under IRC § 1014(b) generally includes property acquired by bequest, devise or inheritance, property the decedent gives to his or her estate, and certain revocable trusts.^[3]

Rationale for stepped-up basis

One possible explanation for the stepped-up basis rule under IRC § 1014 is to avoid the difficulty of ascertaining a decedent's adjusted basis in property that could have been held for decades.^[4] A second theory is that a decedent is not likely trying to evade taxes by passing property at death, so mandating carryover basis, which would preserve the gain in the beneficiary, is unnecessary.^[5] Third, the federal government imposes estate taxes on transfers of wealth at death based on those assets values as of that date.^[6] Were no step up in basis allowed, the federal government could potentially receive a windfall from estates subject to estate tax by recovering federal estate tax based on capital assets' values as of a decedent's date of death, while also receiving capital gains tax when such assets are sold by an estate or a beneficiary based on the difference between the value of the asset when sold and the price at which such asset was purchased by a decedent.

Sunset provision

Prior to Pub. L. 111–312,^[7] IRC § 1014(f),^[8] provided that this section would not apply to decedents dying after December 31, 2009. As of December 2010, the anticipated sunset was removed with the passage of the "TAX RELIEF, UNEMPLOYMENT INSURANCE REAUTHORIZATION, AND JOB CREATION ACT OF 2010".^[9]

References