When creating your estate plan, it is important to consider how income taxes may impact your beneficiaries. In order to do this, you need to have a basic understanding of cost basis rules. The following information will help you understand cost basis so that you can have meaningful discussions about the impact of capital gains tax on your estate with your estate planning attorney and tax professional.
WHAT IS COST BASIS?
Cost basis is the value you paid for an asset. Simply stated, basis equals cost. Certain costs incurred in purchasing the property may also be included in the initial cost basis.
WILL MY COST BASIS EVER CHANGE?
Your cost basis can change due to capital improvements or depreciation of property. The cost basis of securities (stocks, bonds, funds, etc.) may change due to a variety of factors, including amortization, accretion, return of capital, and mergers. After factoring in any changes, your new basis is referred to as your adjusted basis.
IF I GIFT AN ASSET, WHAT IS THE RECIPIENT’S COST BASIS?
The general rule is that when you gift property, the recipient will receive a carryover basis. This means that the recipient’s basis will be the same basis that you had in the property. However, if the property had depreciated in value by the time of transfer, the new recipient’s basis cannot be determined until the time of sale. At that time, depending on the sale price, the basis may be the donor’s basis, the fair market value on the date of gift, or the sale price. The purpose of this rule is to prevent a donor from transferring a capital loss to the recipient.
WHAT HAPPENS TO THE HOLDING PERIOD OF PROPERTY THAT I GIFT?
Your holding period will transfer to the recipient of the gift. For example, if you held the property for nine months at the time of the gift, then the recipient’s holding period starts at nine months.
IF PROPERTY PASSES AT MY DEATH, WHAT IS THE BENEFICIARY’S COST BASIS?
When property is included in your estate, the beneficiary will receive a stepped-up basis. This means that your beneficiary’s basis will generally be the fair market value of the property as of the date of your death. If your property has decreased in value, the adjustment to date of death value could be a step-down. There is an exception to this date of death valuation rule if an alternate valuation of your estate is beneficial to you from an estate tax standpoint. If you think this may apply to your situation, you should discuss the alternate valuation rules with your attorneyand tax professional.
AT MY DEATH, WHAT WILL HAPPEN TO THE COST BASIS OF MY JOINTLY OWNED PROPERTY?
If you hold property with your spouse as tenants by the entirety or joint tenants with rights of survivorship, your spouse will be treated as inheriting your half of the property. This means that the surviving spouse will get a full step-up in basis for one-half of the property. The surviving spouse’s half of the property will not get a step-up. For example, if you and your spouse jointly purchased an asset worth $10,000, you each would have a cost basis of $5,000. During your joint lives, assume the value of the asset increases to $20,000. At your death, your spouse would maintain his or her initial $5,000 cost basis for his or her half of the property and inherit a $10,000 cost basis for your half. This would leave the surviving spouse with a $15,000 cost basis. If the asset is owned jointly with a non-spouse, the new basis is determined by the percentage of the purchase price contributed by the decedent. If the decedent contributed 100%, then all of the basis steps up to the date of death value. If the decedent only contributed 50%, then only 50% of the basis steps up to the date of death value.
AT MY DEATH, WHAT WILL HAPPEN TO THE COST BASIS OF COMMUNITY PROPERTY?
In community property states, the surviving spouse gets a complete step-up in basis to the fair market value of the property at the deceased spouse’s death. In the example above, your spouse’s cost basis would become $20,000 at your death. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. The community property rules vary from state to state, and you should discuss with a local attorney any questions about what constitutes community property.
WHAT HAPPENS TO THE HOLDING PERIOD OF MY PROPERTY AT MY DEATH?
The holding period of the property in the hands of your beneficiary will be long-term regardless of how long you or your beneficiary holds the property.
|Assume an owner paid $2,000 for an asset (his/her cost basis):
|At time of transfer asset had …
|Method of Transfer
|New Owner's Basis
|Declined in Value to $1,000
|Retained Same Value of $2,000
|Increased in Value to $3,000
|The amount paid for the asset (plus certain costs incurred in purchase).
|Carryover basis. However, if property depreciates, recipient’s basis is to be determined (TBD) at time of sale.
|Transfer at Death
|Value of the asset as of decedent’s date of death (or six months after date of death if eligible for alternate valuation).
For more information, see IRS Publication 551, Basis of Assets.
Stifel does not provide legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation.