You bought your home decades ago for $120,000. Today, it’s worth $400,000. What happens when your children inherit it? That’s an incredible amount of growth — and a substantial asset — making tax planning essential for anyone interested in preserving family wealth.
When it comes to passing on a home, it’s called the step-up in basis, and it can be a hidden win for your family. The way your home is passed on, either gifted during your lifetime or inherited after death, can dramatically affect how much of its value your heirs keep.
What is Step-Up Basis?
There are a few terms to understand when talking about the step-up basis. To understand how this works, here are a few key terms:
- Cost Basis: The original purchase price of the home. $120,000 in our example.
- Capital Gains Tax: The tax you pay on the profit from selling an asset.
- Step-up in Basis: The IRS allows the cost basis of an inherited asset to reset to its market value on the date of death.
Without the step-up, the beneficiary would be looking at a profit of:
$400,000 – $120,000 = $280,000. State and federal capital gains taxes would apply to the $280,000.
Thankfully, with the reset of the step-up, if the home is valued at $400,000 at the time of death, and sold for $400,000, you’ll pay zero in capital gains tax. We must emphasize, this can eliminate large capital gains taxes if the home is sold soon after.
If you hold the property and value rises, you still greatly benefit from the step-up, but some taxation may come into play. It’s important to review this with an advisor, as tax implications can vary based on how long the property is held and its location.
Common Mistakes to Avoid When it Comes Passing on a Home
Gifting property, before you pass, while well-intended, may come with real tax ramifications. This is a common train of thought if you need to downsize or move into a care facility.
The step-up (aka the reset of the cost basis) simply doesn’t happen if you pass on your home while you’re still living. If you pass on the family home you purchased for $120,000 back in the ’90s to your son, he’ll be faced with:
- Cost Basis: $120,000
- Step-Up Basis: Does not apply
- Sale Price: $400,000 (matching current market value)
- Taxable Gain: $280,000 — triggering thousands, if not tens of thousands, of dollars in taxes going to Uncle Sam.
You can see where we’re going here. If your son inherits the same house and sells:
- Cost Basis: $120,000
- Step-Up Basis: $400,000
- Sale Price: $400,000 (matching current market value)
- $0 taxable gain. Your son keeps all the gain.
As you can see, the second scenario of your son receiving your home as an inheritance after your passing greatly increases the value of the gift thanks to the time you put into managing your wealth and maximizing your inheritance with thoughtful tax planning.
A Few Steps to Consider
If you want to ensure your home is passed on and will benefit from the step-up basis, there are a couple of key steps to take sooner rather than later:
- Know that adding a child to the deed as a co-owner could eliminate the step-up.
- Have clear estate planning documentation. A will or trust is the route many will go to help avoid probate or other unintended complications.
- Talk with a trusted financial advisor or estate planning attorney and share your wishes. The correct language and documentation can reduce stress for your loved ones once you’re gone.
Final Thoughts
The step-up basis is a simple yet often overlooked piece of tax information you can use to make your home a powerful financial gift. Of course, the sentiment will still be there. If you’ve made it this far, we know you’re truly looking out for your loved ones.
Documenting your clear intentions is always advised when it comes to leaving an inheritance. If you’re wondering where to start, schedule a meeting with one of our financial advisors today. Legacy planning is a piece of the financial planning puzzle we help people like you with every day.
About Foundation Wealth Management
Foundation Wealth Management is a CPA-led organization, that provides financial planning services and tax planning support; services and outcomes vary based on each client’s circumstances. Our team includes qualified professionals, such as CPAs and CFP®s, who are integral to our service offerings. Our team includes 3 Certified Financial Planners: Burt Hutchinson, CPA, CFP®, Paul LaViola, CFP®, and Stephen McDade, CFP®.
As Fee-Only planners, we are compensated directly by clients rather than through commissions from brokerage or insurance products, which we believe helps align our services with client goals.
