The Retirement Corporation of America

Get Ready To Learn What "Basis" Is All About

ANYONE WHO INHERITS assets from you probably won't want to own them for life. Rather, they may very well want to sell the investments or the house that you left them. When they do sell, they will owe a capital gains tax on the difference between the "basis" of the asset and the price it brings when it is sold.

And what is the basis of the asset? Basically, it is the value of the asset when it was acquired. And this is where the 2001 tax law really made things complicated--almost beyond belief. It did so by rolling back what is known as a "step-up" basis.

Under the old law, when you died all the assets in your estate got a step-up in basis. Their value was no longer the price you had paid for them, but their value as of the date of your death. Say you bought Marvelous Marshmallow stock at $10 a share. By the time you die, its price has climbed to $1,000 a share. You leave the stock to your son, who wants to sell it at $1,000 a share.

Under a step-up basis, the stock was revalued on the day you died. No longer was the basis the $10 a share you paid for the stock, but the $1,000 the stock was worth when you died. Instead of facing a $990-per-share taxable capital gain when the stock is sold--the difference between the $10 purchase price and the $1,000 sale price--your son faces no taxable gain at all. That's because the basis is no longer $10 per share, but $1,000.

Where We Are Heading

The step-up basis stays around until December 31, 2009. Then we get a variation of what is called a "carryover" basis. In other words, your basis is no longer the fair market value at your death, but either the fair market value at your death or the price you paid for the shares, whichever is less.

Unless the price of the stock stayed depressed the entire time you owned it, the basis to whomever inherits the stock will be the price you paid for it. If the person wants to sell the stock, he or she will face a taxable capital gain on the difference between your purchase price and the eventual sale price.

At the least, you will have to start keeping very detailed records on your basis for every asset that will be in your estate.

Granted, with everything computerized today, and with so many people managing their assets through programs like Quicken, it is easier to calculate basis than it was in the late 1970s. That is the last time Uncle Sam tried to use a carryover rather than a step-up basis. (For the record, a carryover basis was abandoned as being unworkable in the 1970s after a trial of less than two years.) On the plus side, if and when the estate tax does truly vanish, the maximum tax on all the appreciation your assets piled up would be the 20 percent capital gains rate, not the 50 percent peak estate tax rate.

Still, it adds one more complexity to estate planning. This is still something else to be discussed with the attorney preparing your estate plan. Obviously, it adds to your record-keeping chores. It may cause you to rethink how you will want your assets distributed after death.

Finally, this proposed shift from a step-up to a carryover basis adds value to making gifts of assets today, even if there is a chance the estate tax is repealed. Once you make the gift, all appreciation belongs to the donee. The most tax-efficient gifts are those gifts that are made to someone in a lower tax bracket--minor children, for instance.