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Inherited Assets – Stepped-Up Basis

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–          What is “Stepped-Up Basis?

At death, the beneficiary of an inherited asset (including stocks, bonds, and real estate) will receive the asset with a basis equal to the fair market value of that asset at the date of death.

For example, if a beneficiary inherits a house that decedent purchased for $50,000 but was worth $500,000 at the date of decedent’s death, then the beneficiary will receive that house with a basis of $500,000. If the beneficiary turns around and sells that property for $500,000, he or she will not have any tax liability because there is zero gain in the house. Alternatively, if the decedent had sold the house before his or her death, then the decedent would have had $450,000 in gain, subject to tax.

–          How do trusts work with “Stepped-Up Basis?

One limitation of certain trusts is that trust property is generally not eligible for a “step-up” in basis at a beneficiary’s death. This presents a conundrum in that an individual must choose whether to take advantage of a trust structure or keep the asset individually titled to benefit from the step-up in basis.

–          How do we get the best of both worlds?

Taking advantage of well-established tax principles eliminates this either/or choice.  One solution is to create a provision in the trust agreement called “the contingent general power of appointment (CGP).”  This allows trust property to be included in a beneficiary’s taxable estate at death in order to qualify for a step-up in basis, as long as that will not cause any increase in estate tax.  Consequently, trust property with previously unrealized capital gains can be sold with no capital gains tax liability. A second solution is create a provision in the trust agreement which allows the grantor to transfer assets of equal value into the trust in order to transfer assets of equal value out of the trust. This essentially allows the grantor to transfer high basis assets into the trust for low basis assets.

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