What is the step-up basis rule?

Step-Up Basis Rule: A Tax Benefit for Inherited Assets

The step-up basis rule is a provision in the U.S. tax code that allows inherited assets to receive a stepped-up basis, effectively resetting their value for tax purposes to the date of inheritance. This provision provides a significant tax advantage to beneficiaries by eliminating capital gains taxes on appreciation that occurred during the deceased’s lifetime.

How the Step-Up Basis Rule Works

Normally, when an asset is sold for a gain, the seller must pay capital gains tax on the difference between the sale price and the asset’s original cost basis. However, the step-up basis rule overrides this general rule for inherited assets.

For inherited assets, the recipient’s basis in the asset becomes its fair market value on the date of the deceased’s death. This means that any appreciation in the asset’s value that occurred during the deceased’s lifetime is not subject to capital gains tax when the asset is sold by the beneficiary.

Benefits of the Step-Up Basis Rule

The step-up basis rule provides several significant benefits to beneficiaries, including:

• Elimination of capital gains taxes on inherited assets: By resetting the asset’s basis to the fair market value on the date of inheritance, the step-up basis rule effectively eliminates capital gains taxes on appreciation that occurred during the deceased’s lifetime.
• Increased flexibility in asset disposition: With the step-up basis, beneficiaries can sell inherited assets without incurring capital gains taxes. This provides them with greater flexibility in managing their portfolios and realizing gains when it is most beneficial for them.
• Incentive to hold appreciated assets: The step-up basis rule encourages beneficiaries to hold appreciated assets, as they can avoid capital gains taxes on any future appreciation. This can lead to more efficient and stable investment strategies.

Impact on Federal Revenue

While the step-up basis rule benefits beneficiaries, it has a negative impact on federal revenue. By eliminating capital gains taxes on inherited assets, the government loses out on potential tax revenue. This reduction in revenue can put a strain on government spending and lead to higher budget deficits.

Conclusion

The step-up basis rule is a significant tax provision that provides valuable benefits to beneficiaries of inherited assets. It effectively eliminates capital gains taxes on appreciation that occurred during the deceased’s lifetime, allowing beneficiaries to maximize their returns on these assets. However, this provision also has a negative impact on federal revenue, which should be carefully considered when evaluating its overall effectiveness.