What Is a ‘Step-Up’ in Basis in Estate Planning?

Estate planning is a complex field, filled with intricate concepts and legal jargon that can often be difficult to navigate. One such concept is the 'Step-Up' in Basis, a term that is frequently used but not always fully understood. This article aims to demystify this term, explain its significance, and explore its implications in estate planning.

Imagine this scenario: you own a condominium in Austin, a city you once called home. Now, you've retired to New Braunfels and are currently renting out the condo. You have plans to sell this property in the next year or two. However, a question arises: if you didn't sell it and put it in a trust, would the condo get the stepped-up Basis if it were sold after your demise? This question was recently posed in a Market Watch article entitled, "Will our condo get a step-up in basis if we put it in trust?"

Before we delve into the answer, let's first understand what a 'step-up' in Basis is. The Basis of a property is essentially its purchase price plus any cost of improvements made to it. For instance, if you bought your condominium for $500,000 and spent $100,000 on a kitchen remodel, the Basis of your property would be $600,000. The capital gain, which is the difference between the net proceeds from the sale and the Basis, is what you would owe taxes on. So, if you sold the condo for $1 million, your capital gain would be $400,000.

The 'step-up' in Basis is an adjustment that occurs when a property owner dies. The Basis is adjusted to the property's fair market value at the time of death. This is known as a 'step-up' because property values generally increase over time, meaning the new Basis is typically higher than the old one.

In our example, if the condo had a market value of $1 million at the time of the owner's death, that would become the new Basis. If the property were sold, any capital gain would only be the increase in value after the owner's death. This can significantly reduce the tax burden on the heirs.

So, back to our original question: would the condo get a 'step-up' in Basis if it were put in a trust? The answer is yes but with some caveats. The property must be part of the decedent's taxable estate to receive a step-up in Basis. All property in a revocable trust created by the decedent is part of their taxable estate.

Trusts can be beneficial for out-of-state property to avoid two probate processes upon the owners' death, one in their state of residence and one where the out-of-state property is located. These are usually revocable trusts. Irrevocable trusts may be used for other purposes, such as asset protection.

Whether an irrevocable trust is part of the decedent's taxable estate depends on how it's drafted. Therefore, if your goal is to include the property in the estate for a step-up in Basis, it's crucial to consult with an experienced estate planning attorney to draft an irrevocable trust accordingly.

In conclusion, a 'step-up' in Basis is a significant aspect of estate planning that can have substantial tax implications. Understanding this concept and considering it when planning your estate is essential. As always, it's advisable to consult with a knowledgeable estate planning attorney to guide you through this complex process.

Reference: Market Watch (April 7, 2023) “Will our condo get a step-up in basis if we put it in trust?”