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Eliminate Capital Gains Tax on Inherited Real Estate Using “Stepped-Up Basis”

Jul 22, 2015 | Written by: Lori K. MacWilliam, Esq. |

Some people are unaware of the advantages of the IRS allowance for “stepped-up basis” for real property. If grown children inherit the home in which they grew up, and in which their parents have lived  for many years, the home has probably appreciated in value quite a bit. That could mean significant capital gains for the children.  But the good news is that this gain, no matter how much, would be erased as a result of “stepped-up-basis at death” allowances. The date-of-death fair market value of an inherited asset — such as a house — becomes the new basis and is subsequently used for calculating capital gains taxes when the inherited asset is sold.

Here’s how it works:  let’s say Mr. Jones (Senior) bought his house for $50,000. When he dies and leaves it to his son, Junior, it’s worth $150,000. If Junior sells it right away for $150,000, he will owe no capital gains tax. The “stepped-up” basis allowance means that Junior does not have to declare a $100,000 “profit” based on the difference between what his father paid for it and what it’s now worth.

If Junior holds on to the property for several years, and the house rises in value so he can sell it for $200,000, then he will owe capital gain tax — but only on the $50,000 difference between the valuation when he inherited it and the price he sold it for, assuming he has not made any further improvements to the property that would increase the basis.

If Mr. Jones had deeded the house to Junior prior to his death, the “stepped-up” basis would be gone.  Mr. Jones’ basis of $50,000 would become Junior’s basis in the house.  This would not change on Mr. Jones’ death because the house would have already been transferred to Junior, and if Junior sold it after his dad’s death for the same $200,000 price, the capital gains tax bill would be based on $150,000 – the difference between his father’s basis and the selling price.

Note from author:  thanks to Craig Ort of Coldwell Banker’s Clinton office for the inspiration for this entry!


Lori K. MacWilliam, Esq. focuses her law practice on real estate, estate planning & administration, and general corporate matters. Please feel free to contact her at 908-735-5161 or via email.