When I talk to my clients about estate planning, I stress the importance of understanding the tax implications associated with every decision they make within their estate plan. Moreover, the tax implications may apply not only to them, but to their beneficiaries and surviving loved ones as well. Capital gains taxes, for example, have the potential to significantly diminish the value of property if gifted to a beneficiary. Allow me to explain how a step up in basis works within your estate plan so you have a better understanding of how to combat the potentially negative influence taxes may have on your plan.
What Does a “Step Up” in Basis Mean?
Basis is essentially the cost of an asset, initially plus, in the case of real property the additional amounts that were paid to properly maintain the asset. As time goes on the value of the asset often increases to an amount higher than the basis. This increase difference is referred to as gain, which can be taxable at capital gains rates. According to our tax laws upon the death of the owner of the property, their heirs receive a step-up in basis, which refers to the adjustment of the value of an appreciated asset upon inheritance to current market value. This adjustment effectively resets the cost basis of the asset, such as real property, to its value at the time of inheritance, thereby essentially wiping out the gain. For the beneficiary or heir, this means that the value of the property for tax purposes is not what the decedent originally paid for it, but rather its fair market value at the time of inheritance. Hence the beneficiary avoids paying the capital gain tax.
Basis and Capital Gains Taxes
To comprehend the significance of this concept, imagine that John inherits a property from his Aunt Mary who recently passed away. Mary purchased the property decades ago for $100,000. Over the years, the property appreciated significantly and is now valued at $1.2 million. If John decides to sell the property immediately after inheriting it, there would be a gain of $1.1 million based on the original cost of the property. Absent the use of a step up in basis, John would be obligated to pay capital gains taxes on that gain of $1.1 million. If his aunt had gifted the property to John before her death he would be responsible for those taxes. Because John inherited the property, however, any capital gains taxes John incurs will be calculated using the stepped-up basis of $1.2 million, not the original purchase price of $100,000. Advantages of a step up in basis include:
- Reduction of Capital Gains Tax: As illustrated in the example above, the step-up in basis can significantly reduce the capital gains tax burden for heirs. By resetting the cost basis to the property’s current market value at the time of inheritance, heirs can minimize the taxable gain when they eventually sell the property.
- Simplified Record-Keeping: Inherited property often comes with a complicated history of transactions and adjustments to its cost basis over time. The step-up in basis simplifies this process by establishing a new, higher basis value at the time of inheritance. This eliminates the need for heirs to trace back and account for previous improvements causing adjustments, making tax reporting more straightforward.
- Preservation of Wealth: For families with substantial real estate holdings, the step-up in basis can help preserve wealth across generations. By minimizing the tax liability associated with capital gains, heirs can retain more of the property’s value when transferring it to subsequent generations.
- Incentive for Long-Term Holding: Since the step-up in basis is contingent upon inheritance, it incentivizes heirs to hold onto inherited property for a longer duration. By doing so, they can potentially benefit from further appreciation in the property’s value without incurring significant tax consequences upon eventual sale.
- Step Up Works for Marketable Securities: Step up in Basis is not limited to real property. It also applies to stocks and other marketable securities as well as businesses.
How Does a Step Up in Basis Work If the Property Is Jointly Owned?
When real property is jointly owned, it can make calculating tax liabilities even more complicated. Usually, jointly owned assets are treated as separate property for tax purposes, meaning only 50 percent of the asset will receive a step up in basis if the asset is gifted upon the owner’s death. For example, imagine that John’s Aunt Mary co-owned the house with her sister Jane at the time of her death. Only Mary’s half of the house would receive a step up in basis. If John and Jane decided to sell the house after John inherited his half, Mary’s half of the value would receive a step up in basis, meaning her original half ($50,000) of the purchase price would step up to $600,000 (half of the current value of the property. Jane’s half, however, would remain valued at $50,000 (her original half). The value of the property for capital gains tax purposes at the time of the sale would be $650,000, meaning a gain of $550,000 if the property sold for $1.2 million.
Do You Need Assistance Incorporating a Step Up in Basis into Your Estate Plan?
For more information, please contact our estate planning office in Owings Mills, Maryland by calling 410-654-3850 to schedule an appointment.
- What You Need to Know about the Medicaid Estate Recovery Program in Maryland - July 7, 2026
- How Divorce Affects Your Estate Plan in Maryland - January 9, 2026
- Should the Details of My Maryland Estate Plan Remain Private? - January 8, 2026
