Do you know your stepped up basis rule? Say what?


While some of you may find the following narrative a bit of a yawn, I would argue that it is big. Very big.

Sadly, I have witnessed far too many highly educated, professionally successful but financially illiterate folks who do not understand the incredibly important stepped up basis rule and subsequently paid a dear price for their ignorance. Therefore, I encourage you to read on with great interest.

Your “basis” is usually what you paid for the asset and every investor should know about the stepped-up basis ambiguity, as it is a commonly overlooked tax benefit that can help minimize taxes. Did you know that rules for gifted assets are much different than those of inherited assets? For example, when you inherit (someone dies) noncash assets, the basis gets “stepped up” to the date of death.

Furthermore, let’s assume that Harry purchased 500 shares of XYZ stock in 1990 at a cost of $20 a share. Harry’s total investment (minus commission) is $10,000 (500 x $20). Currently, XYZ stock has appreciated to $80 a share. Therefore, Harry’s 500 shares are now worth $40,000 (500 x $80), and he has an unrealized gain of $30,000 ($40,000-$10,000). If Harry sells the stock at $80, he will be subject to a capital gains tax on the $30,000 profit. Assuming a 15 percent tax rate, Harry would owe the IRS $4,500 in taxes.

Now, let’s accept that Harry did not sell XYZ stock because he was tax savvy regarding the stepped up basis rule. Harry wanted his two children to inherit XYZ stocks upon his death, so his kids would be entitled to a stepped up basis on XYZ. In the final analysis, Harry’s daughter and son would receive a stepped up basis upon Harry’s date of death. Said differently, Tori and Trey would each receive 250 shares of XYZ with a new cost basis of $80; not the $20 that their dad originally paid! Yep, if Tori and Trey sell the stock at $80, they would pay zero in capital gains taxes! Thus, their incredibly smart father discovered a way to save $4,500 on taxes.

As you can see, the stepped up basis rule offers an enormous advantage. Of course, everyone’s situation is different, which is why I recommend that before you make a decision of gifting noncash assets, you speak with your legal or tax and financial advisers to determine the most appropriate planning approach for you. By the way, tax savvy Harry also discovered that when one puts the words “The” and “IRS” together, it spells “THEIRS!” ‘Nuff said!