Assets that don't get a step-up in basis at death typically include retirement accounts (IRAs, 401(k)s), annuities, income in respect of a decedent (IRD), life insurance proceeds (for beneficiaries), and assets gifted before death, which retain the original cost basis (carryover basis). Also, assets held in irrevocable trusts or C-corporations generally miss out on the step-up, though exceptions exist for certain partnerships and S-corps.
Typically, assets you place in trust for your beneficiaries are eligible for a step-up in basis if the trust is revocable, and therefore considered part of your taxable estate. But with an irrevocable trust (which exists outside of your estate), trust assets do not receive a step-up in tax basis.
When you pass away, the assets held within the LLC will typically receive a step-up in basis, just as they would if you held them personally. The situation becomes more complex if your LLC has multiple members or is taxed as a partnership.
The cost basis of inherited stock is generally based on the fair market value of the shares at the time of the original owner's death, rather than when they were first purchased. This is based on the step-up in basis rule, which can potentially reduce capital gains taxes on inherited assets.
While inherited assets typically receive a step-up in basis (which can reduce or eliminate capital gains tax upon sale), improper titling, gifting during life, or incorrect trust setup could forfeit that benefit.
It doesn't apply to all assets: Certain items, like retirement accounts (IRAs, 401(k)s) and annuities, don't get a step-up in basis. Those are subject to different tax rules.
The Step-Up in Basis loophole is used to circumvent capital gains taxes, or to pay the least amount of this type of inheritance tax as is legally possible. This loophole can be used on inherited assets that have appreciated in value from the time they were purchased.
The most tax-efficient way to leave a home to a child usually involves leaving it in your will for them to inherit, which qualifies for a stepped-up tax basis (reducing capital gains tax if sold) and avoids immediate gift taxes, though trusts (like Revocable Living Trusts for probate avoidance or QPRTs for advanced planning) or Transfer-on-Death (TOD) deeds (where available) offer control and probate avoidance, while outright gifting is generally less tax-efficient due to inherited basis issues. Consulting an estate planning attorney is crucial to choose the best method for your specific situation.
You can avoid capital gains taxes on inherited property by minimizing the time for appreciation. Selling immediately after inheritance typically results in minimal capital gains tax because there's little time for the property to appreciate beyond its stepped-up basis.
Assets exempt from probate typically include those with named beneficiaries (life insurance, retirement accounts), jointly owned property with rights of survivorship, assets held in a living trust, and sometimes specific items like homestead property or a certain value of vehicles/household goods, depending on state law, allowing direct transfer to heirs without court involvement.
Charity exemption
Like the spousal exemption, assets passing to charity on death are exempt from inheritance tax. As such, if an entire estate passes to charity, there will be no inheritance tax due.
What is the 6-month rule for stepped-up basis? It refers to an alternate valuation date used for estate tax purposes. Executors can elect to value assets six months after death if it reduces both the estate's value and tax liability.
10 Ways To Pass Your Inheritance On to Your Children
Give more money away
Lifetime gifting is a straightforward way to begin reducing your IHT bill. By gifting money during lifetime, that would have been part of an inheritance anyway, you reduce the size of your estate so that there is smaller amount subject to IHT on your death.
You may have to pay Capital Gains Tax when gifting an asset to someone, depending on who that person is. You do not have to pay CGT on assets you gift (or sell) to a spouse or civil partner, unless you're separated and did not live together during the tax year in question.
In practice, most inherited assets after death are stepped up, not stepped down. This is because financial assets passed on to heirs are often long-term holdings that grow in value over the years.
Irrevocable trusts are not traditionally eligible for stepped-up fair market value basis.
Here are five ways to avoid paying capital gains tax on inherited property.
If you inherit a property and make it your primary residence, you may be eligible for private residence relief. This relief can reduce or eliminate the capital gains tax liability when you sell the property.