Step-Up in Basis: What Missouri Property Owners Should Know Before Selling Property

Have you heard the term “step-up in basis” in estate planning? If you own a home, investment property, or other real estate that has appreciated significantly in value, understanding how basis works could be important before you decide to sell the property or transfer it to a trust.

A step-up in basis can affect the amount of capital gain recognized when property is sold after the owner’s death. For Missouri residents who own valuable or highly appreciated property, working with an experienced estate planning attorney in Missouri can help you understand how your estate plan may affect the future tax treatment of that property.

What Is a Step-Up in Basis?

The basis of property is generally its original purchase price, plus certain costs and improvements. When the property is sold, the taxable capital gain is generally based on the difference between the property’s adjusted basis and the net proceeds from the sale.

For example, suppose you purchased a condominium for $500,000 and later spent $100,000 on qualifying improvements. Your adjusted basis could be $600,000. If you subsequently sold the condominium for $1 million, there could be a $400,000 capital gain, before considering other applicable adjustments and exclusions.

A step-up in basis can change that calculation when the owner dies.

Generally, property included in a decedent’s estate for federal estate-tax purposes receives a new basis equal to its fair market value at the owner’s death, subject to the applicable tax rules. Because real estate often appreciates over many years, the new basis may be substantially higher than the original purchase price.

For example, if the condominium originally had a $600,000 adjusted basis but was worth $1 million when the owner died, the basis could be adjusted to $1 million. If the property were then sold for $1 million, there generally would be little or no capital gain attributable to appreciation that occurred during the deceased owner’s lifetime.

Why Does a Step-Up in Basis Matter Before Selling Property?

A property owner may be considering selling an appreciated property during their lifetime. In some circumstances, however, the owner may also want to consider what would happen if the property were retained until death.

For example, imagine you own a rental property that you purchased many years ago for substantially less than its current market value. Selling it today could result in a significant capital gain. If the property instead passes to your beneficiaries at death and qualifies for a basis adjustment, the beneficiaries may receive a basis reflecting the property’s fair market value at the owner’s death.

This does not mean that everyone should delay selling property. There are many financial, family, tax, investment, and estate-planning considerations that should be evaluated before making that decision.

Can Property in a Trust Receive a Step-Up in Basis?

A common misconception is that putting property into a trust automatically eliminates the possibility of receiving a step-up in basis. That is not necessarily the case.

Assets held in a properly structured revocable living trust are generally included in the grantor’s taxable estate at death and generally receive a basis adjustment under the applicable federal tax rules. A revocable trust can also be useful for other estate-planning purposes, including helping avoid probate for property properly transferred to the trust.

The situation can be more complicated with an irrevocable trust. Whether property held in an irrevocable trust receives a basis adjustment can depend on the specific provisions of the trust and whether the property is included in the decedent’s estate under the applicable federal estate-tax rules.

Therefore, the type of trust, the way it is drafted, and the overall estate plan matter.

What About Out-of-State Property?

Trust planning can be particularly useful when someone owns real estate outside the state where they live.

For example, a Missouri resident might own a vacation home, rental property, or condominium in another state. Without appropriate planning, owning out-of-state real estate can potentially result in a second probate proceeding in the state where the property is located.

A properly funded revocable trust may help avoid ancillary probate for qualifying out-of-state property while still allowing the property to remain within the owner’s estate for purposes of the basis adjustment.

Step-Up in Basis and Your Estate Plan

A step-up in basis is only one consideration when deciding whether property should be sold, gifted, or transferred to a trust.

Other issues can include:

• Capital gains taxes
• Federal estate taxes
• State tax considerations
• The type of trust involved
• Whether the property is included in the owner’s taxable estate
• Asset protection goals
• Medicaid or long-term-care planning
• Probate and ancillary probate
• The owner’s plans for the property
• How the property will ultimately pass to beneficiaries

Importantly, transferring appreciated property during your lifetime can have very different tax consequences from allowing the property to pass at death. Before selling or transferring a highly appreciated property, it is wise to understand the potential consequences as part of your overall estate plan.

An experienced Missouri estate planning attorney can review your property, trust documents, and estate-planning goals to help you understand whether preserving a potential basis adjustment should be part of your planning.

Frequently Asked Questions About Step-Up in Basis

1. What is a step-up in basis?

A step-up in basis generally adjusts the tax basis of qualifying property to its fair market value as of the owner’s date of death. This can reduce the amount of capital gain recognized if the property is later sold.

2. Does property in a revocable trust receive a step-up in basis?

Generally, property in a properly structured revocable trust is included in the grantor’s estate at death and can receive a basis adjustment. The specific facts and applicable tax rules should be reviewed with an estate planning and tax professional.

3. Does property in an irrevocable trust receive a step-up in basis?

It depends. The tax treatment of property in an irrevocable trust can depend on the trust’s terms and whether the property is included in the decedent’s estate under applicable federal estate-tax rules. The trust should be reviewed before assuming that a step-up will or will not apply.

4. Should I sell appreciated property now or keep it until death?

There is no one-size-fits-all answer. The decision can involve capital gains taxes, estate planning, family circumstances, investment goals, and other considerations. Before selling or transferring substantially appreciated property, consider having an estate planning attorney review how the transaction fits into your overall plan.

Talk With a Missouri Estate Planning Attorney

Understanding the step-up in basis can be an important part of planning for a home, rental property, vacation property, or other appreciated assets. The way property is owned—and whether it is included in your estate at death—can affect the tax consequences for you and your beneficiaries.

Contact Beck, Lenox & Stolzer Estate Planning & Elder Law, LLC for all of your estate planning needs by booking a call: https://beckelderlaw.com/book-a-call/

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