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  • Writer's pictureJose Roman

What is Basis in Estate Planning?

By: Jose Roman


Basis in Estate Planning

Estate planning is a crucial aspect of financial management, ensuring that your assets are distributed according to your wishes after your passing. One important factor to consider in estate planning is the basis of your assets. Basis plays a significant role in determining capital gains taxes and maximizing the value of your inheritance. In this blog post, we will delve into the concept of basis and explore its relevance within the context of estate planning. Understanding basis will empower you to make informed decisions and optimize the financial outcomes for your beneficiaries.


What is Basis?


Basis is the original value of an asset for tax purposes. It is used to determine the capital gain or loss when the asset is sold or transferred. The basis is critical because it determines the amount of taxable gain or loss, which directly affects the tax liability for the estate or the heirs who inherit the asset.


Different Types of Basis


Several methods are used to determine the basis of an asset. The most common methods include:


Purchase Price: This method calculates the basis by considering the actual amount paid for the asset at the time of purchase. It includes the purchase price, any commissions or fees paid, and any improvements made to the asset.


Inherited Basis: When an asset is inherited, the basis is generally "stepped-up" to the fair market value of the asset at the time of the original owner's death. This means that the basis for the heir is the value of the asset on the date of the owner's death, rather than the original purchase price. This is important because, generally speaking, when the person inheriting the property later sells it, they will realize less of a gain, and as a result pay less income tax on the sale of the asset.


Gifted Basis: When an asset is received as a gift, the basis generally "carries over" from the donor to the recipient. In other words, the recipient assumes the donor's original basis. Recipients of gifts generally will realize greater gains on the sale of gifted assets and as a result will incur a higher income tax liability when compared to an asset that was inherited and enjoyed a stepped-up basis.


Gifting an asset during your lifetime or waiting to leave an asset to someone as an inheritance have both pros and cons that should be considered while drafting your estate plan. In the next sections we detail somethings to consider whether to gift an asset or to leave it as an inheritance.


Importance of Basis in Estate Planning


Capital Gains Tax: The basis of an asset is crucial in determining the capital gains tax liability. Capital gains tax is levied on the difference between the sale price of an asset and its basis. The amount of tax levied is determined by the type of asset and the amount of time the asset was held prior to realizing any gain or less. It is important to discuss any potential capital gains tax consequences with an experienced professional prior to completing a transaction. By understanding basis and applying appropriate strategies, you can potentially minimize the taxable capital gains and reduce the overall tax burden on your estate or your beneficiaries.


Maximizing Inheritance: The stepped-up basis for inherited assets can be advantageous for beneficiaries. Since the basis is adjusted to the fair market value at the time of the original owner's death, any appreciation in the value of the asset before the sale by the heir will likely not be so significant as to a incur large tax liability. This allows beneficiaries to inherit assets with a higher value while potentially avoiding significant tax liabilities.


Estate Tax Planning: Basis also plays a role in estate tax planning. If the total value of your estate exceeds the estate tax exemption threshold, the heirs may be subject to estate taxes. By understanding the basis of your assets, you can strategically plan and make informed decisions to minimize the potential tax burden on your estate.


Strategies to Optimize Basis


Gifting Strategies: Gifting assets during your lifetime can help transfer assets to your beneficiaries and potentially reduce your taxable estate. However, when gifting assets, it's important to consider the basis implications. If the asset has appreciated significantly, it may be more beneficial for the recipient to inherit the asset, taking advantage of the stepped-up basis upon your passing. If the asset has not appreciated significantly since your initial purchase, then the asset may be a perfect candidate to gift during your lifetime instead of waiting to leave it as an inheritance. In this scenario any gain realized will be minimal and the asset will not have enjoyed an appreciable step-up in basis either.


Charitable Giving: Donating appreciated assets to charitable organizations can be a tax-efficient strategy. By gifting appreciated assets, you can avoid capital gains tax and potentially receive a tax deduction for the fair market value of the asset at the time of the donation. Always discuss your options for charitable giving with a professional as the rules surrounding such gifts can be complex and have tax consequences.


Trusts and Estate Planning Tools: Utilizing trusts and other estate planning tools can help preserve the basis of assets and provide more control over their distribution. The type of trust that you create determines whether you are making a gift or simply leaving an inheritance for someone after your passing. If you make a gift in trust, certain steps must be followed in order for the gift to satisfy present interest rules. If these rules are not followed the "gift" will not have been completed and the asset will be considered a part of your estate for estate and inheritance tax purposes. Always consult with an attorney when you are draft trusts to make sure they meet you intentions and all legal requirements.


Strategic Timing of Asset Sales: If you have assets with significant appreciation, carefully consider the timing of their sale. Selling assets during your lifetime may incur capital gains tax, whereas if the assets are held until after your passing, the beneficiaries can take advantage of the stepped-up basis. Assets that have not appreciated significantly make great candidates for lifetime gifts or sales because of the smaller amount of gains that will be realized. Consulting with a financial advisor or tax professional can help you evaluate the potential tax consequences and make informed decisions regarding the timing of asset sales and gifts.

Keeping Detailed Records: Maintaining accurate records of the original basis and any improvements made to the assets is crucial. This documentation will be essential for your beneficiaries when they inherit the assets and need to determine the basis for future transactions or potential tax purposes. Proper record-keeping will help ensure that the basis is accurately reported and that any eligible deductions or exemptions are appropriately applied.


Conclusion


Basis is a critical component of estate planning that can have a significant impact on the taxes owed by your estate or beneficiaries. By understanding the concept of basis and implementing appropriate strategies, you can optimize the financial outcomes of your estate plan. Maximizing the stepped-up basis for inherited assets, strategically gifting assets, utilizing trusts, and timing asset sales can all contribute to minimizing capital gains taxes and maximizing the value of your family's inheritance. As estate planning can be complex and unique to individual circumstances, it is advisable to consult with a qualified estate planning attorney or financial advisor to ensure that your estate plan is tailored to your specific goals and objectives. Taking proactive steps to manage your basis will help preserve your wealth and ensure a smoother transfer of assets to your loved ones.


Don't wait until it's too late - start planning your estate today with our help. Contact us to schedule a consultation and let us help you protect your assets, minimize taxes, and ensure that your wishes are carried out. Your future and your loved ones' future are too important to leave to chance - let us help you create a comprehensive estate plan that gives you peace of mind. Contact us today!

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