When creating your estate plan, it’s important to consider how income taxes may affect your beneficiaries. To do this, you must have a basic understanding of cost basis rules. The following information will help you understand the 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.
The cost basis is the value you paid for an asset. Simply put, basis equals cost. Certain costs of purchasing the property may also be included in the original cost basis.
Your cost basis may change due to capital improvements or property depreciation. The cost basis of securities (stocks, bonds, funds, etc.) can change due to a number of factors, including amortization, growth, return on capital and mergers. After taking into account any changes, your new basis is referred to as your adjusted basis.
The general rule is that when you gift property, the recipient receives a carryforward basis. This means that the beneficiary’s basis will be the same basis as you had in the property. If the property had decreased in value at the time of the transfer, the new recipient’s basis can only be calculated at the time of sale. At that time, depending on the sale price, the basis may be the donor basis, the fair value on the gift date, or the sale price. The purpose of this rule is to prevent a donor from passing on a capital loss to the recipient.
WHAT HAPPENS TO THE WITHDRAWAL PERIOD FOR
Your holding period is transferred 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.
RECIPIENTS’ COST BASE?
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 property’s fair market value on the date of your death. If your property has decreased in value, the adjustment to the date of death value may be a decrease. There is an exception to this date of death valuation rule if an alternative valuation of your estate is beneficial to you from an estate tax point of view. If you believe this may apply to your situation, you should discuss the alternative valuation rules with your attorney and tax professional.
UPON MY DEATH WHAT WILL HAPPEN TO THE EXPENSES
If you own property with your spouse as tenants of the whole or joint tenants with rights of survivorship, your spouse will be treated as heir to your half of the property. This means that the surviving spouse gets full savings in the basis for half of the assets. The surviving spouse’s half of the assets does not receive an increase. For example, if you and your spouse jointly purchased an asset worth $10,000, you would each have a cost basis of $5,000. Over the course of your lives together, assume the value of the asset increases to $20,000. Upon your death, your spouse will retain his or her original cost basis of $5,000 for his or her half of the property and inherit a cost basis of $10,000 for your half. This would leave the surviving spouse with a cost base of $15,000. If the asset is owned jointly with a non-spouse, the new basis is determined by the percentage of the purchase price that the deceased contributes. If the deceased contributed 100%, the entire basis increases to the value of the date of death. If the deceased only contributed 50%, only 50% of the basis will increase to the date of death value.
UPON MY DEATH, WHAT WILL HAPPEN TO THE COST BASIS OF THE COMMUNITY PROPERTY?
In community property states, the surviving spouse gets a full step up in basis to the property’s fair market value upon the deceased spouse’s death. In the example above, your spouse’s cost basis would be $20,000 upon your death. Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Community property rules vary from state to state, and you should discuss with a local attorney questions about what constitutes community property.
WHAT HAPPENS TO THE HOLDING PERIOD OF MY PROPERTY UPON MY DEATH?
The tenure of the property in the hands of your beneficiary will be long-term, regardless of how long you or your beneficiary hold the property.
Assume an owner paid $2,000 for an asset (his/her cost basis):
For more information, see IRS Publication 551, Basis of Assets.
Stifel does not provide legal or tax advice. You should consult your legal and tax advisors about your particular situation.