If you’re planning your estate, or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes. This “cost” is also referred to as the Fair Market Value (FMV).
What is Fair Market Value?
Fair Market Value determines what the value of your property is based on the current market. In the event that you inherit property, the fair market value basis (also known as the “step-up and step-down” rules) state that an heir receives a basis in inherited property equal to its date-of-death value.
The rules apply to inherited property that’s includible in the deceased’s gross estate, and also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.
Types of Fair Market Value Rules
It’s crucial for you to understand the fair market value basis rules so that you don’t pay more tax than you’re legally required to.
For example, if your grandfather bought ABC Corp. stock in 1935 for $500 and it’s worth $5 million at his death, the basis is stepped up to $5 million in the hands of your grandfather’s heirs. Additionally, all of that gain escapes federal income tax forever.
In the above example, if your grandfather decides to make a gift of the stock during his lifetime (rather than passing it on when he dies), the “step-up” in basis (from $500 to $5 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it (just $500), plus a portion of any gift tax the donor pays on the gift.
A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.
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