Step-Up (adjustment) in Basis — How Does it Work with a Revocable Trust to Save Money?
Disclaimer: This information is for educational purposes only and is not legal advice. You should consult with a qualified attorney to discuss your specific situation. The law is complex and constantly evolving.
Understanding the Basics: Basis and Step-Up
Basis: In simple terms, basis is the original cost of an asset for tax purposes. When you sell the asset, the difference between the sale price and the basis is the capital gain (or loss).
Step-Up in Basis: Federal tax law allows for a "step-up" in basis when an asset is inherited. This means the basis of the asset is adjusted to its fair market value (FMV) on the date of the deceased's death. This can significantly reduce or eliminate capital gains tax when the inherited asset is eventually sold.
California Law and Community Property
California is a community property state. This is crucial to understanding the step-up in basis rules for married couples.
Community Property: Generally, assets acquired during a marriage are owned equally by both spouses as community property. Separate property is what you owned before the marriage or received as a gift or inheritance during the marriage.
Joint Tenancy vs. Community Property: While spouses can hold assets in joint tenancy with right of survivorship, it's often less advantageous from a tax perspective than holding them as community property, especially in California.
Revocable Trusts and the Step-Up
A revocable trust (also known as a living trust) is a popular estate planning tool. When properly structured, assets held in a revocable trust are treated the same as if they were owned outright by the grantor (the person who created the trust) for income and estate tax purposes. Here's how the step-up works for married couples with a revocable trust:
Death of the First Spouse:
Community Property Assets: Under Internal Revenue Code Section 1014(b)(6), when the first spouse dies, both the deceased spouse's and the surviving spouse's share of the community property held in the revocable trust receive a step-up in basis to the fair market value on the date of the first spouse's death. This is a significant benefit of holding assets as community property.
Separate Property of the Deceased Spouse: The separate property of the deceased spouse held in the trust also receives a step-up in basis to its fair market value on the date of death.
Separate Property of the Surviving Spouse: The surviving spouse's separate property remains unchanged with no step-up in basis.
Death of the Surviving Spouse:
Upon the death of the surviving spouse, all assets remaining in the revocable trust receive another step-up in basis to their fair market value on the date of the surviving spouse's death.
Important Considerations:
Proper Trust Drafting: The revocable trust must be carefully drafted to ensure it reflects the couple's intent regarding community property and separate property. The trust should clearly state how assets are to be managed and distributed after the death of either spouse. Ambiguity can lead to disputes and unintended tax consequences.
Asset Titling: Assets must be properly titled in the name of the trust (or, more precisely, the trustee of the trust). Failing to properly title assets can prevent them from being considered part of the trust for tax purposes. We advise clients on retitling assets.
Community Property Agreements: Sometimes, couples enter into agreements that characterize separate property as community property (or vice versa). These agreements must be carefully reviewed and considered in the estate plan, as they can affect the step-up in basis.
Estate Tax: While the step-up in basis is beneficial for capital gains, it's separate from estate tax. If the estate's value exceeds the federal estate tax exemption (which is quite high), estate taxes may still be due.
Changes in the Law: Tax laws are subject to change. It's important to periodically review your estate plan with an attorney to ensure it remains up-to-date and effective.
California Proposition 19: While Proposition 19 primarily affects property tax reassessments, it's crucial to consider its implications alongside step-up in basis planning. This is especially true when real property is involved.
Why Yu & Yu Law?
As estate planning attorneys, we provide the following benefits:
Relevant Knowledge: We have in-depth knowledge of California community property law, federal tax law, and estate planning principles.
Customized Planning: We tailor estate plans to each client's specific needs and circumstances.
Risk Mitigation: We help clients avoid common estate planning pitfalls that can lead to unintended tax consequences or family disputes.
Peace of Mind: We provide clients with the peace of mind that their estate plan is properly structured and will achieve their goals.
Disclaimer: This information is for educational purposes only and is not legal advice. You should consult with a qualified attorney to discuss your specific situation. The law is complex and constantly evolving.
Let’s Talk
If you’re curious what a custom estate plan would cost for your situation, schedule a free consultation with us.
No pressure, just real answers.
View our pricing
Schedule a free consultation
At Yu & Yu Law, we make estate planning clear, comfortable, and completely personalized.