What is a Step-Up in Basis and How Does It Affect Real Estate Ownership?

What is a Step-Up in Basis and How Does It Affect Real Estate Ownership?

Disclaimer: This article does not replace advice from legal, financial, construction, zoning or tax professionals. The content is for educational purposes solely and is provided without warranties or representations.

Understanding the concept of “step up in basis” becomes crucial when dealing with property and its tax implications. Here’s a simplified breakdown;

Significance of Step Up in Basis

The concept of step up in basis holds importance for individuals inheriting property who aim to minimize taxes when selling it. Typically capital gains tax is calculated based on the difference between an assets selling price and its original purchase price.

Example

Suppose your family purchased a property for $100,000, which now holds a value of $500,000. In such a scenario you would normally owe taxes on the $400,000 profit. However with a step up in basis adjustment the property’s value is reset to its market value, at the time of inheritance. When you sell the inherited property for $500,000 the adjustment would mean that you won’t incur any capital gains.

Understanding Step Up, in Basis

A step up in basis resets the property’s tax basis to its market value at the time of inheritance thereby reducing the capital gains tax burden. In California despite Proposition 19 affecting property tax reassessment the step up in basis for capital gains tax remains unchanged. This rule is advantageous for California residents, including those residing in San Diego.

8 Common Mistakes to Avoid

1. Neglecting to Get an Appraisal – Failing to appraise a property at the time of inheritance can lead to disagreements with tax authorities. Result in tax filings.
2. Lack of Understanding about Step Up in Basis – Not being aware of the step up in basis could result in unnecessary capital gains taxes. It’s advisable to educate yourself or seek advice from a tax professional to grasp how the step up in basis can work to your advantage.
3. Misinterpreting Proposition 19– Proposition 19 impacts property tax reassessments. Not the step up, in basis. Misunderstanding this difference might lead to tax planning efforts. It’s crucial to comprehend how Proposition 19 affects your circumstances and plan accordingly.
4. Mistakes, in Calculating Capital Gains– Using the purchase price of the adjusted basis can lead to paying more taxes than necessary. Make sure to factor in the adjusted basis when working out capital gains.
5. Lack of Understanding Regarding Holding Period – Inherited property is generally considered to have a term holding period making it eligible for lower capital gains tax rates. Misunderstanding this concept may result in tax liabilities. Keep in mind that inherited property is automatically categorized as term for tax purposes.
6. Neglecting Detailed Documentation– Failing to keep records of the property’s value and relevant transactions can complicate tax reporting. Potentially lead to disputes. It’s crucial to maintain records, including the property’s market value upon inheritance along with any upgrades completed at the property.
7. Failure to Seek Professional Advice– Trying to navigate intricate tax laws without expert guidance can lead to costly mistakes. It’s advisable to seek assistance from tax professionals those versed in real estate and inheritance regulations. Incorrect Distribution Among Beneficiaries. When dealing with beneficiaries distributing the basis incorrectly can trigger tax complications. Allocate the basis among beneficiaries based on their ownership interests. Ensure documentation.
8. Considering Expert Counsel – It is advisable to consult with a professional with California’s estate and tax laws for effective navigation, through these regulations.

Seeking Expert Advice

It’s advisable to seek guidance from a informed individual, with California’s estate and tax laws to effectively navigate these regulations.

Types of Properties Covered 

The increase in basis applies to all inherited real estate including residential and commercial real estate.

Recent Case Study

One of our clients recently inherited a property with rents significantly below market value. Due to AB1482, California’s rent control law, raising the rents to market rates was not an option. When the property taxes were reassessed, the cash flow from the property decreased.

Given the circumstances, the client decided it made more sense to sell the older building, which had substantial deferred maintenance and below-market rents, and reinvest in a property that was turnkey and achieving market rents. This strategic move provided the family with a better investment vehicle, offering a property with minimal maintenance expenses and strong cash flow.

This case study highlights how smart investment decisions can transform an inherited challenge into a lucrative opportunity, ensuring the family’s financial stability and peace of mind.

Closing Thoughts

If you need assistance, feel free to reach out to discuss your options for selling inherited real estate.

 

Seth Watje & Adam Cairo Principals at Starker West Inc – an independent, full-service commercial real estate brokerage firm that specializes in representation of clients in the acquisition and disposition of multifamily assets throughout San Diego County.  For more information contact at Watje@starkerwest.com/ Cairo@starkerwest.com , 619-358-3748/619-300-0173 or on the web at WWW.STARKERWEST.COM