To be able to understand what a step-up in basis is all about, you need to have an understanding of the lay of the land when it comes to capital gains taxes. The capital gains tax can come into play if you are in possession of assets that appreciated after you originally acquired them.
You are not required to pay the tax on an ongoing basis as the assets appreciate. The capital gains tax is only applicable when you realize a gain. A gain is realized when you sell an appreciated asset and take possession of the liquidity.
There are two types of capital gains in the eyes of the IRS: long-term capital gains and short-term capital gains. The rate of taxation for each respective type of gain is different.
A short-term capital gain is a capital gain that is realized less than a year after the original acquisition of the asset. These gains are taxed at your regular income tax rate.
When you digest the above, you can intuitively deduce that a long-term capital gain is a gain that is realized more than a year after you acquired the asset. The highest income earners pay a 20 percent long-term capital gains rate, but most people pay 15 percent.
Step-Up in Basis
If you were to inherit assets that appreciated while they were in possession of the decedent, you would get a step-up in basis. This means that the appreciation that took place before you acquired the assets would not be your responsibility. For capital gains purposes, the value of the assets would be equal to their value when you inherited them.
Assets that have been conveyed into a revocable living trust do get a step-up in basis when they are distributed to the beneficiaries after the passing of the grantor.
We should point out the fact that the beneficiaries would be responsible for any future appreciation from a capital gains perspective.
Living trusts provide many different benefits. Assets in the trust can be distributed to the beneficiaries outside of probate, and this allows for efficient asset transfers because probate can be time-consuming.
A living trust also allows you to include spendthrift protections if you are concerned about the money management abilities of a beneficiary or beneficiaries.
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