The “Stepped up Basis” (new value) is a new basis which is available to property received through inheritance. The basis of a property is the value used to determine gain or loss for income tax purposes. Basically, it is the cost of the property (what you paid for it).
The new value is determined by the of a value at the date of death of the person who owned it. This is the value of the property used to determine gain for income tax purposes.
As you’ll read below there are tax advantages to ensuring that real estate passes through to heirs as inheritance, rather than as a gift during your lifetime.
When does a property receive “Stepped up Basis?”
Where it is received as an inheritance, either through a Revocable Living Trust or through a will (there will be probate fees and taxes when passed through a will), the piece of real estate receives a stepped up basis. However if it is received as a gift, for example, through a quitclaim deed, then the it retains the basis (value) established by the person who made the gift.
For Example, let’s assume a man purchases a piece of home for $10,000 in 1940 and it was worth $1,000,000 at the time of his death. If the heirs of that man received the home as an inheritance (for example through a Revocable Living Trust) then the new value of that home would be $1,000,000. This means that if the heirs sold the house for $1,000,000, no income tax liability would accrue. However if the man transfered the house to the heirs during his lifetime, then the heirs would not benefit from the a Stepped up Basis and the basis would the original $10,000. The heirs would then have to pay Capital Gains tax on $990,000 if they sold the house for the same $1,000,000.
Clearly, transferring the property to your heirs before your death can become a severe income tax trap.