Understanding cost-basis step-ups


The original value of an asset used for tax purposes, adjusted for corporate actions, distributions, wash sale rules and income reallocation.

Seems straightforward, doesn’t it? But this simple number can make a big difference when it comes to taxes. The Internal Revenue Service uses your cost basis to calculate how much you’ve gained or lost by owning a particular asset, including tangible property and investments. You typically will owe short- or long-term capital gains taxes on the gains realized when you sell the asset, if the asset has appreciated between when you purchased it and when it’s sold. Your cost basis matters when it comes to estate planning, too. Here’s why.

Step-ups in action
Say you purchased 1,000 shares of a tech company stock in 1980, when it was approximately $10 per share, and held on to it. Decades later, the stock is now valued at $116 per share.
Scenario 1 You sell the stock yourself.
You’ll reap $106,000 in gains but also owe Uncle Sam $21,200 in long-term capital gains taxes (assuming the 20% rate, which could be higher for those subject to the Medicare surtax).
Now, consider this.
Scenario 2
You bequeath your shares to your children.
When your children inherit, they enjoy a “cost-basis step-up” to the stock’s fair market value (FMV) on the date of your passing ($116/share). The stock also is automatically considered a long-term holding, regardless of whether you yourself held it for more than a year. The step-up narrows the amount of gain that would be subject to long-term capital gains taxes if the stock appreciates further. If your children immediately sell the inherited shares, they will owe $0 in capital gains taxes, even though the stock appreciated significantly during your ownership.
Tax savings: That’s a potential savings of $21,200 with cost-basis step-ups as part of your estate and tax planning.
There are a couple of variations of cost-basis step-ups, including ones that take joint ownership of the original asset into account and one that uses an alternate valuation date. Some accounts qualify for an alternate valuation six months from the original date of death.
Because taxes are complicated, it’s wise to consult with your financial and tax professionals in order to stay within the guidelines.
If the asset in question has lost value, a step-down will occur, so selling the asset, rather than bequeathing it, may make more sense.


Article provided by Bill Martin, CFP®, 1845 Capital of Raymond James, 1400 N McColl, Suite 101, McAllen, TX 78501. For more information, please contact
Bill Martin, CFP® at 956-331-2777.
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