What is the step-up basis when selling an inherited home?
Bob: I have a trust, and the house is in the name of the trust. How do I sell that without having to pay tax on it, because what they're saying is if this death tax passes, that they will charge you when you leave the house to your children or whoever. They'll charge you the difference in purchase and sale price, and all of it will be taxed.
Attorney Tom Olsen: Bob, I've got good news for you, I'm not sure what you're listening to, but I think you must have misunderstood them. Bob, are we talking about selling it during your lifetime, or what happens once you pass away?
Bob: When I pass away.
Tom: Are you married or single, by the way, Bob?
Bob: Married.
Tom: Bob, there is a good provision left over in the Internal Revenue Code called the step-up basis. The step-up basis says that when you and your wife both pass away, and your children inherit this home from you, their basis for capital gains tax purposes will be the value at the date of your death. I see that you might have paid $35,000 for it back in the day, and let's say at the moment you and your wife have passed away it's worth $400,000. At that moment in time your kids turn around and sell it for $400,000, they'll pay absolutely no capital gains taxes.
If they hold on to it for a year and sell it for $425,000, they'd pay capital gains on their $25,000 profit. Bob, we're talking about the Step Up Basis in the Internal Revenue Code. It's a good thing. Occasionally I hear about Congress might do away with the step-up basis, but there's nothing certain about that as far as I know. Nothing's happening on it right now. Bob, does that answer your question for you?
Bob: Thank you very much. That's exactly what I need to hear.
Tom: Okay, Bob.
Bob: You have a nice day.
Tom: Thank you, Bob. I appreciate it. Yes, it's called the step-up basis. It's a good thing. It's available to you on any asset, on all assets, whether it's your home, or investment property, or the stock that you bought in Tesla, or your Bitcoin even, I suppose. The key to it is that your kids cannot own that asset until you've passed away, meaning they inherit it through your trust, through a ladybird deed, through probate.
Stated another way, if you add your child's name to the deed to your property, which I'm telling you do not do, but maybe you do it anyway. Yes, you might have avoided probate by adding their name to the deed, but you may cost them a lot more in capital gains taxes. Again, that's a step-up basis. Robert, do many of your clients ask you about that?
Attorney Robert Hidock: Almost every single one of them. Because everybody's so concerned about paying taxes and what's going to happen to my house. Because a lot of our clients, they're coming to you for the ladybird deed for estate planning purposes. For me, if they haven't already done it, I'm doing it to protect it from Medicaid, and they'll all ask me about it and I say, "Well, I believe in it so much, my mom's house has a ladybird deed on it." Every conference that I give them, I tell them about the step-up basis. Once they hear that, they're starting to feel more comfortable, yes, there's not going to be any taxes. Okay.
Tom: Robert, when I do my workshop on easy ways to avoid probate, one of the slides I do is called death and taxes and I start off by telling people, "Hey, it's almost all good news for you," or specifically your kids because almost everything they inherit from you is going to be tax-free. For example, let's say you as a parent, you go out and earn $15,000, you pay Uncle Sam $3,000 in income taxes, you got $12,000 left over, it's in the bank account. You pass away, your kids inherit that 12,000, they're not going to pay income taxes on it because you've already paid income taxes on it. Compare that to your traditional IRA.
As you know with your traditional IRA, as you withdraw that money, you will pay income taxes on that money because you've never paid income taxes on that money. When you pass away and your kids cash out your traditional IRA, not your Roth IRA, traditional IRA, they will pay income taxes on that money because you've never paid income taxes on that money. Yes, they do have a beneficiary IRA where your kids can roll it over into their name and withdraw that money over the next 10 years. That just means they'll pay taxes on it over the next 10 years. Great question. We appreciate it so much.