Amassing assets alone does not ensure a comfortable retirement or a financially secure future for loved ones after you are gone. You must also take steps to protect the assets you acquire. One important way to maximize the assets you can pass down to loved ones is to include tax avoidance strategies in your comprehensive estate plan. Doing so can reduce, or even avoid, a hefty tax obligation for you, your estate, and even your beneficiaries. Understanding how the “basis” of an asset is determined, and the effect that has on the value of the asset gifted to a beneficiary is imperative. With that in mind, the Indianapolis estate planning attorneys at Frank & Kraft explain how basis impacts the transfer of property.
What Does the “Basis” of an Asset Mean?
You have likely heard discussions of late about potential changes to how the “basis” of an asset is calculated for tax purposes. The term “basis” refers to the value of a piece of property for the purpose of determining certain taxes. When the value of a property increases or decreases the basis also increases or decreases. This change in the value, or change to the original basis, is used to determine if capital gains taxes are due when a property is sold. Although there are several exceptions and loopholes to the general rule, capital gains taxes are paid when you sell an asset for more than what you paid for it. By way of illustration, imagine that you purchased a vacation home ten years ago for $400,000 and recently sold the home for $700,000. You realized a “capital gain” of $300,000 on the sale and would owe capital gains tax on that $300,000 profit.
How Does Basis Apply to Gifted Property?
Now imagine that instead of selling that vacation home, you gifted it to your adult daughter upon your death. If traditional basis rules apply, your daughter would owe a hefty chunk of capital gains taxes upon the sale of that property, making the gift noticeably less valuable. The good news is that gifted property often gets to use a “stepped-up” basis instead of the original basis. In short, a “stepped-up” basis allows a beneficiary to use the value of an asset at the time it was passed down instead of using the donor’s original basis. The basis is “stepped-up” to the value at the time of death of the donor. In the vacation home example, your daughter would be able to use the stepped-up basis of $700,000 if she sold the property instead of using the original $400,000 basis. As such, your $700,000 gift does not immediately lose value because of the imposition of capital gains taxes.
Basis and Jointly Owned Property
Jointly owned property can be more challenging to understand when determining how basis applies to a transfer. In most states, the default method is to treat jointly owned assets as “separate property” for tax purposes. As such, the amount that is included in a decedent’s estate is only 50 percent of the assets’ value, meaning only 50 percent of the value of the property will be eligible for a “step-up” in basis. The remaining 50 percent, (the surviving spouse’s half) keeps the original basis. By way of illustration, using the vacation property example, assume that you own that jointly with your spouse and you live in a separate property state. If your spouse passes away, his/her 50 percent will get a step-up in basis to the current value of 700,000, meaning his/her original basis of $200,000 (half of the original basis) will be increased to $350,000 (half of the stepped-up basis). Your basis, however, remains at $200,000. The combined basis in the property is now $550,000 for the $700,000 property, meaning capital gains tax would be due on the difference of $150,000.
Contact Indianapolis Estate Planning Attorneys
For more information, please join us for an upcoming FREE seminar. If you have additional questions or concerns about how the basis of property impacts the transfer of that asset, contact the experienced Indianapolis estate planning attorneys at Frank & Kraft by calling (317) 684-1100 to schedule an appointment.