If you inherit property, such as stocks, how do you know how much it's actually worth? The fair market value basis rules affect how much tax you will pay. 415 Group Senior Manager Dominic Reolfi, CPA/ABV, MT, explains what to do if an inherited stock isn't publicly traded.
If you’re planning your estate, or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes.
Fair market value rules
Under the fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value. So, for example, if your grandfather bought ABC Corp. stock in 1935 for $500 and it’s worth $5 million at his death, the basis is stepped up to $5 million in the hands of your grandfather’s heirs — and all of that gain escapes federal income tax forever.
The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, and those rules also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.
Step up, step down or carryover
It’s crucial for you to understand the fair market value basis rules so that you don’t pay more tax than you’re legally required to.
For example, in the above example, if your grandfather decides to make a gift of the stock during his lifetime (rather than passing it on when he dies), the “step-up” in basis (from $500 to $5 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it (just $500), plus a portion of any gift tax the donor pays on the gift.
A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.
These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. Contact us for tax assistance when estate planning or after receiving an inheritance.
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The “step-up” basis rules can save taxpayers significant tax dollars with some proper planning. An important part of that is determining what the stepped-up basis is.
If the stock is publicly traded, it is fairly easy to determine the appreciation as of the date of death or the alternative valuation date. But what if the stock isn’t publicly traded? If the person that has passed away owns a private company, that value isn’t nearly as clear. This often requires an outside business valuation.
If you are uncertain about the potential effect of the “step-up” basis rules and if it applies to your situation, it is important to talk to a trusted advisor so you can take advantage of any tax savings.
At 415 Group, we have performed thousands of business valuations and have helped countless clients with tax planning strategies. Contact us today.