Carryover basis on a life-time transfer (i.e., gift)
When property is transferred before death (e.g. gifting) the recipient receives carryover basis of the donor’s original cost basis in the property. In effect, the recipient steps into the shoes of the donor (i.e., the donor’s basis is now your basis; and the property’s holding period is the donor’s holding period). When this gifted property is eventually sold, any appreciation in that property’s value from the original acquisition date to the date the recipient ultimately sells the property is recognized as taxable income by the seller (donee). Gifting appreciated property can result in good tax strategy especially if the donee is in the 12% tax bracket (or less) as he/she will pay 0% federal tax on long term capital gains.
Step Up or Step Down in basis (property transferred at death)
In contrast to carryover basis, a “step up” basis is a reset of the basis to the recipient. When property is transferred from a decedent to an heir, the original basis of the decedent is stepped up or replaced with the fair market value at the date of the decedent’s death. In some cases, the estate may elect to value property using an alternate valuation date which is the fair market value six months after the date of death. Any appreciation in the property’s value from the date of death (or the alternate valuation date) to the date the recipient sells the property is recognized as taxable income by the recipient.
Also, the heir could keep the property until death and give the property to a new heir, at which time the property would receive another step-up in basis to the current fair market value.
A “step-down” occurs if the decedent’s property has declined in value since being acquired. In that case, the basis is lowered to the date-of-death value. Proper planning calls for taking steps to avoid this loss of basis. Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can take the tax advantage of the tax loss.
Not all types of property are eligible for the step-up in basis treatment upon death.
Following are several examples of assets that are eligible for step-up.
- Stocks, bonds and mutual funds
- Real estate
Following are several examples of assets that are not eligible for step-up.
- 401(k) accounts and pensions
- Tax deferred annuities
- Certificates of deposit and money market accounts
Please contact your Wegner tax professional if you need assistance with gift or estate planning.