Stepped Up Basis

By: Martin M. Shenkman, CPA, MBA, JD

Basis refers to the amount generally used for tax purposes to calculate gain or loss on a sale of an asset. In simple terms it is the price paid for the asset, plus the cost of post acquisition improvements, less depreciation allowed or allowable (if you didn't claim depreciation you were entitled to, it is still applied to reduce basis). Stepped Up Basis is an increase in the basis of an asset, such as at death of the owner, usually to the fair market value of the asset. Example: You purchased raw land for $100,000. Five years later you build a fence around the land and pave a drive, all for a cost of $20,000. Your tax basis is $120,000. No depreciation was allowed or allowable. On your death the land was worth $300,000. The basis of the land is stepped up to $300,000. If instead you gave the land to your children before death their tax basis would be $120,000, called "carry over basis". Even though the land had appreciated to $300,000 by your death, because you had given it away before death. This basis "step up" will eliminate any capital gains inherent in the asset. Basis step up becomes more complex if the asset is owned by an entity. If the land was owned by a corporation you in turn owned, you would get a basis step up in the stock of the corporation, but there would be no basis step up for the underlying land. If you owned 50% of a partnership or limited liability company that owned the land, the partnership or the limited liability company (taxed as a partnership) would have to make a special election under the partnership tax law provisions (Section 754) to adjust the basis in the land. In the year 2010 the estate tax is scheduled to be repealed and with it will disappear (really, be modified) the above basis adjustment. This is an increase in the adjusted tax basis (cost to purchase, less depreciation if applicable, plus improvements if applicable) of an asset to the fair market value of the asset at death. In 2010, if the executor chooses for the estate to be subject to the estate tax, the assets in the estate will all be stepped up (assuming they are appreciated) in this manner without limit. If in 2010 the estate is subject to the carryover basis rules the step up in tax basis may be limited to $1.3 million for bequests to anyone other than a spouse and an additional $3 million step up on bequests to a spouse (or trust qualifying for similar treatment).

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