1. Step-up basis:
When an individual passes away, most of their assets receive a step-up in basis to the assets fair market value as to the date of death. As a result, the tax basis of inherited assets is adjusted to their current value. This can help minimize capital gains taxes for the beneficiaries in the event that the asset is sold. For example, if your parent purchased a home in 1970 for $50,000 and you inherited the home in 2023 when it was worth $650,000 and later sold the home for $650,000, you would not owe any capital gains taxes.
2. Carry-over basis:
Gifts during an individual's lifetime generally do not receive a step-up in basis but instead receive a carry-over basis. A carry-over basis means that the gift recipient inherits the donor's basis in the asset. For example, if your parent purchased a home in 1970 for $50,000 and in 2023 gifts you the home which is now worth $650,000, your tax basis in the home would be $50,000. In the event that you were to sell the home for $650,000 and no exclusions applied, you would owe capital gains taxes on $600,000.
It is important to note that tax basis rules are separate from estate tax. Depending on an individual's estate planning needs it might be better to maximize the step-up basis by holding on to an asset until death or in the alternative it might be better to gift an asset to take advantage of gift tax exclusions to lower your overall estate tax burden. Each individual's circumstance is different and consulting with an attorney can help you understand which option is best for you.
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