Don’t lose your step-up

Probate can be a lengthy and expensive process. Some people avoid it using sophisticated strategies by paying an attorney to create and monitor documents and situations. Some people, with good intentions, try to avoid it with as little cost as possible by simply adding the name of their beneficiary(ies) to their deeds and/or accounts. This does avoid probate, but there can be added liability risks and tax implications to your beneficiary.

“Fred” bought a piece of property in Port St. Joe a few years back for $250,000; it’s now worth $600,000. If Fred adds his 55-year-old son “Jack,” to his deed, Jack can provide a death certificate and some legal submissions upon Fred’s passing and get the property solely in his name. They probably saved 3-5% in probate costs.

But, if Jack sells the property a month or two later, he has to pay capital gains tax on the sale based upon the same values his father would have had to pay tax (for simplicity and article length limitations, I am ignoring the half-step-up and alternate valuation date). With a sale price (net) of $600,000 and a basis of $250,000, the IRS hears, “I made a profit of $350,000.” The IRS will want tax of up to 20% on the profit. That’s a whole lot more expensive than 3-5% in probate costs. Plus, if Jack rear-ended someone in traffic and got sued, Fred’s property is potentially at risk in a lawsuit.

Instead of gifting the property during his lifetime, Fred could have passed the property to Jack after his death using a will (yes, it goes to probate), a revocable living trust, or some other attorney-advised strategy. If this had occurred, the IRS would say: “What was the property worth on the day Fred died?” Answer: $600,000. Then the IRS asks, “How much did you sell it for?” Answer: $600,000. Total profit: $0. Total tax on $0 profit: $0. Total amount in Jack’s pocket: $600,000. 

This example illustrates a “step-up in cost basis.” Gifts made during a lifetime do not receive a step-up. That’s why tax would have been due based upon the price daddy Fred paid for the property. Transfers of ownership at death receive a step-up. This same principle applies to investment accounts (stocks, bonds, mutual funds) and other non-qualified assets (not IRAs and the like). 

Before you put anyone’s name on your assets, it makes sense to talk with qualified professionals about the pros and cons for your situation. Don’t lose your step-up!

Walter L. Woodrick is a Gulf County resident, a Certified Financial Planner practitioner, and the author of two books. His website is WoodrickFinancial.com. Securities and advisory services are offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC. This information is not intended to be a substitute for specific individualized tax or legal advice. Individual tax or legal matters should be discussed with your tax or legal professional. #549101-1