In most cases, there is a step-up in basis when property is transferred from a decedent. But there are a few exceptions and some subtle distinctions to keep in mind when a client inherits property.
To help make this analysis easier, we have created the “Will I Receive A Step-Up In Basis For The Appreciated Property I Inherited?” flowchart. It addresses some of the most common issues that arise for a client trying to understand their cost basis in the property they inherited. This flowchart considers:
Impact of living in a community property state
Types of property that receive a step-up
Impact of selecting the alternate valuation date
Simple ownership vs. JTWROS vs. tenants in common
Hi, Todd Pouliot, Gateway Financial. Again, visit us at www.mygatewaymoney.com. Love to see you there. And today, we're bringing you a flow chart that we go through quite often. We deal with a lot of clients who have passed – the will has matured and, “What do we do now?” What is the estate planning Administration part and how does all that plan together? And, you know, recently we've had a client who passed away and there were a lot of assets out there and, what do we do and how does it go? And, then the follow-up questions happen after we've done our work. Well, what about taxes? And, those are great questions to ask and hopefully, we've already outlined that and the client's plan beforehand and we can easily answer those questions. So, today's flow chart I thought would be a great way to just describe something that we call step-up in basis and that is when a property is transferred from a decedent and what is that cost basis going to be? So, in most cases, there's what's called a step up in basis when that property is transferred. There are a few exceptions to the rule and some subtle distinctions that we do need to go over when a client inherits property but we want to make the analysis very easy and clear. And, so we have this flowchart called, “Will I Receive A Step Up In Basis For The Appreciated Property That I Inherited?” So, we're going to cover four main areas here: the impact of living in a community property state, the types of property that receive a step up, the impact of selling or selecting the alternative valuation date, and that's a really important thing that we do want to take a moment and just stop and clarify in there and then we want to talk about simple ownership versus joint tenancy with rights of survivorship and tenants in common. So, we're going to share our screen here as we always do and talk to you about this flowchart. The flowchart is, “Did you or your spouse gift the property you inherited to the decedent within one year before their death?” Hopefully, that answer is not yes. Hopefully, that answer is no. We can continue on. But if you did gift the property that you inherited within one year before their death, there is no step-up in basis for the inherited property. They'll just receive the decedent's adjusted basis. And, this is another one that we've run into recently was not just a grandparent to the children – to the grandchildren. Did you inherit the property from your spouse? If the answer is yes, verify with each state whether you live in a community property state and if you do or do not. So, if the answer is yes, is the property in an IRA, 401K, pension, annuity, or irrevocable trust? If the answer is yes, sorry there is no step-up in basis for the inherited property. And, I can hear you all watching this going well why not, that's not fair. Just remember, we don't need a basis on those types of properties because as they're paid out they are taxed at income rates. So, you know, yes, it's bad news there's no step up but just understand why there's no step up is because you really don't have to track a cost basis inside of there. Now, there are some very small rules in very small differential – and everybody's situation is different. There may be some non-deductible contributions to those but again, there is no step-up in basis. So again, if the answer is no, both halves receive a step up in basis to a fair market value if at least half is included in your spouse's gross estate. Now, I'm going to come all the way back in here and I'm gonna find you a nice little area, “Is the property in an IRA pension or annuity or irrevocable trust”? like we saw before if we were not living in one of these states. And, if the answer is no, was the alternate valuation date selected? I just want to pause here because boy, this is really where a lot of self-investors or do-it-yourself investors don't know the rules and don't follow the rules or don't understand the impact of the rules. This alternate valuation date can be up to six months later and selected after the decedent's date of death. And, that can be very impactful, especially in the year 2022, when we're talking about the stock market has dropped and dropped and dropped. You need to be cognizant of how you choose those dates and when that date evaluation date is selected to your benefit or not. So we want to really understand alternate valuation dates, how to select them, why to select them, and what impact they have here. Now again, I don't make these videos an hour long. I want to keep it short sweet and simple but just understand we see a lot of mistakes here that are made. If there is no alternate valuation date selected, your cost basis is based on the fair market value of the date of death. Now, I'm going to keep moving along here. Was the property sold before the valuation date – that alternate valuation date? Now, here's a kicker where I see a lot of people really mess this up. If they have yes, your cost basis is based on the value on the date it was sold. And, since we've had a volatile market, we can't answer that question if it's at a high or low portion of 2022 or whenever you're viewing this video at some later date. That can mean a very large impact on the valuation date on the date it was sold. And again, if it was not, your cost basis is based on the alternate valuation – six months after the date of death. So, that's important. Now, this is also radically important that most people miss – a lot of attorneys I've seen make mistakes on this. A lot of financial advisors I've seen make mistakes on this and we really need to understand. Now what I don't have listed here is, I don't have a transfer on death (TOD). Transfer on death is one of the great things that I use for a lot of our clients, that don't have north of 10 million dollars, that we just want to say, “Hey, let's put this in a TOD account, a single name. TOD to spouse or child or friend or whoever you list as your transfer on death to avoid probate and get your automatic step up and basis. I'm not going to cover that because I just did and that's something that we want all of our clients to do that have south of 10 million dollars. If the decedent was a sole owner, the property receives a step up in basis to the fair market value based on the date selected earlier. And again, that could have been the date of death or the alternate valuation date. Joint tenancy with rights of the survivor (JTWROS). Now, this is a curious one that we see a lot of people make mistakes on. And, the issue is, half of the value receives a step up in basis not the whole thing but the full ownership goes to you. Because again, it was a joint account and this is where people have to talk about control and trust and whatever other issue you may have with the money because we all have money equals feelings – that joint tenancy with rights of survivor, could it have been done better with a TOD? Because remember, if I bought a stock at two dollars, it's now worth ten dollars, if it's a TOD the cost basis would step up to ten dollars but if it's this joint tenancy with the right to Survivor remember half of the value receives a step up in basis. So, be cognizant of that very very strong issue there. And lastly, I don't see it as often but I still see it. And, this is the one that always concerns me says tenants in common. 100 percent of the decedent shares receive a step up in the basis to the fair market value based on the date selected earlier. And again, the ownership must be supported so we want to make sure that you understand it's not only what type of accounts, it's also the titling of those accounts that are important and also select a date and how we move assets from one place to another place to avoid taxation. Now, I just want to take a personal note here and pause and just say listen. What we did recently, I hate taking victory laps, but I'm gonna take one today. We had a client, husband, and wife, very very long-time clients, wonderful in fact, when the wife passed away before the husband and the husband recently passed away. That money, when we started working together a lot of it was in IRA money, so having to move that money through Roth conversions or distributions however, we moved that money out I don't want to go into details but a lot of it ended up into a taxable account. Now, that sounds backward to people if you hear how that works but if you understand taxation it's a big win. So, as the monies have been distributed out to the beneficiaries all of that gets a step up in basis because of that time that it was in the taxable account. And then, there are no IRAs that were left so it's not paid income tax rates. So, anything that the beneficiaries do, if they sell anything, will be taxed at long-term capital gains rates as long as they hold it for 12 months, which I'm hoping that it does. And then, they don't pay income tax rates since they're all still working which is at a higher tax percentage. Now, these are all the things that are really really important to do that a lot of people don't think about doing. And, God bless his soul and he's no longer a client of mine but all that planning and all that work that we did for all those years, boy, it really paid off and I know his beneficiaries don't understand the amount of pain, work, anxiety, and stress that causes but you know what, you know, the easy things are easy to do the hard things are hard to do and the right things are also hard to do. And, we did all the right things, and boy, we really helped them get into a good tax position at the end of life and have to deal with not only the estate plan but obviously the estate administration at the end. So, thanks again for sticking with me on that little side note there and why that was so important to figure out how all this was done. Appreciate you, the ones that hit thumbs up. Subscribers we love you. We thank you very much for coming back and watching our videos and we'll keep bringing you more and more workflows and flow charts and checklists. And again, visit us at www.mygatewaymoney.com thank you, and be well.