Stepped-up basis reduces your heirs' tax obligation by recalculating when the capital gain occurred.
There is a tax benefit for beneficiaries of your estate who receive an asset and later sell it, because inherited assets typically have a stepped-up basis. Normally, when you sell an asset, you need to pay capital gains tax on the difference between your original purchase price (the basis) and the price at which you sold the property. When the asset is inherited by your beneficiary, if not for the stepped-up basis, the property would likely retain your original purchase price as its value for the sake of calculating capital gains tax from any future sale.
However, when your beneficiary receives property with a step up in basis, the original value used to determine capital gains tax (the basis) is the value of the house when they inherited it, and not the value of the property when you first purchased it. That means the beneficiary could owe less capital gains tax on the asset when they sell it, if most or all of the increase in value occurred before the beneficiary inherited the asset.
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If you bought a house for $200,000 and then sold it for $1,000,000, you would generally pay capital gains tax on the $800,000 difference between your sale price and the price at which you purchased the house. If you never sold your house and instead passed it to your child after you die, if not for the stepped-up basis, your child would pay tax on the difference between $200,000 (the original basis) and whatever price they sell the house for. That difference could be huge if they keep the house for decades or even generations.
But if your house is eligible for stepped-up basis, the basis of the house would be recorded as the house's value when it was inherited. If the house is worth $1,000,000 when you die and you pass it on to a loved one, whenever that person sells the house, their capital gains tax will be determined as the difference between $1,000,000 and the future sale price.
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Depending on your tax filing status, you may not need to pay capital gains tax at all, even if the asset is eligible for the step up in basis. That's because the first $250,000 of profit from selling an asset is exempt from capital gains tax if you're a single filer, and the first $500,000 is exempt for married couples selling an asset.
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