Planning your estate? Recently inherited assets? Knowing the “cost” or “basis” of property is important - it can have a big impact on your taxes.

Fair market value rules

The first step is to understand fair market value basis rules. These are also known as “step-up and step-down rules.” Under these guidelines, when an heir receives a basis in inherited property, its value is equal to its date-of-death value. An example: If your grandmother purchased stock in Apple in 1985 for $500 and today it’s worth $10 million, the basis is stepped up to $10 million after it passes to her heirs. The gains made have escaped federal income tax.

Fair market value basis rules come into play for the inherited property as long as it can be included in the deceased’s gross estate. These rules, furthermore, apply to property that’s inherited from a foreign person who isn’t subject to estate tax in the United States. Even if a federal estate tax return is filed!

These rules apply to the inherited portion of the property that’s jointly owned by the inheriting taxpayer and the deceased. However, it’s not applicable to the portion of the jointly-held property that the inheriting taxpayer owned before his or her inheritance. Moreover, fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.

Step up, step down or carryover

Understanding fair market value basis rules will help prevent you from paying more in taxes than legally required.

Let’s talk about your grandmother’s Apple stock again. If they choose to make a gift of it during their lifetime instead of passing it on when they pass on, the “step-up” basis would be lost. Gifted property that has increased in value is subject to “carryover” basis rules. These rules require that the individual receiving the give takes the same basis that the donor had in it (just $500), as well as a portion of any gift tax they paid.

What about “step-downs”? A “step-down” happens if someone passes on and owns property that has declined in value. In these cases, the basis is lowered to the date-of-death value. In planning, we generally try and avoid this loss of basis. Giving the property away prior to death doesn’t preserve the basis because when property with reduced value is gifted, the individual receiving the gift has to take the date of gift value as their basis in order to determine their loss on a later sale.  

Ultimately, a good strategy for property with a reduced value is for the owner to sell before death so they can at least have the tax benefits of the loss.  

While these are the basic rules, other limits and conditions apply. To learn more about ways to handle property in estate planning or if you’ve recently received an inheritance and need guidance on what to do next, contact us today for a free consultation.