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Step-Up Basis and How It Can Pertain to Real Estate

by Kelly Lee McFrederick 02/03/2020

Image by Steve Buissinne from Pixabay

Suppose you’ve inherited your parents’ longtime home. Suppose they paid $100,000 for it, and it’s now worth $300,000. Had they sold it while it was in their possession, they would have avoided paying capital gains tax due to the Taxpayer Relief Act of 1997.

Now that it’s yours, has that tax avoidance opportunity been lost? If you sell it for $300,000, will you have to pay taxes on the $200,000 gain?

The answer is no, and the reason is step-up basis.

What is step-up basis?

When you sell an asset, you may owe capital gains tax. For example, if you buy stock for $10,000 and sell it 10 years later for $15,000, you owe tax on the $5,000 you profited. The original cost, the $10,000, is your basis, and you are taxed on your sale proceeds minus that basis.

If you buy stock, the original cost is your basis. But if you inherit stock, your basis is stepped up to what it’s worth when you inherit. If your mother leaves you that same stock, now worth $15,000, your basis is $15,000, not the $10,000 she paid. The IRS looks at it as if you acquired the stock for $15,000. If you sell it later for $18,000, your taxable gain is ($18,000 - $15,000) or $3,000.

Real estate works the same way. Going back to our example, your basis in the inherited home is $300,000, not the $100,000 your parents paid. If you sell it immediately for $300,000, you've made no taxable profit and you keep everything. You pay no capital gains tax at all. If you sell in a few years for $350,000, you pay tax only on the $50,000 difference. The appreciation that happened while your folks were alive never gets taxed.

Depreciation Benefit

If you decide to rent that house out (or if you inherit an apartment building) there’s yet another benefit. You can depreciate the dwelling at the step-up value, even if the previous owner used it as an income property and depreciated it. For that $300,000 building, you can deduct $10,909 a year from your rent income over the 27 ½ year depreciation period, rather than the $3,636 if your basis had been $100,000. You’d pay taxes on $7,273 less every year for a long time.

Step-Up During Your Lifetime

Under special circumstances you can take advantage of step-up basis on real estate when you give it away. You can donate property to a charity and deduct the step-up amount rather than your original basis. However, rules are strict. There are appraisal requirements, limitations based on taxable income and the charity must use the property in its work rather than resell it.

There is an even more specialized opportunity under the recent Tax Cuts and Jobs Act to sell appreciated property, invest in a designated opportunity zone, and defer or avoid taxes on your gain.

In both of these specialized cases, you must follow stringent regulations. Don’t wade in without the help of an expert.

About the Author
Author

Kelly Lee McFrederick

Kelly Lee McFrederick, a native of Clearwater Beach, Florida and graduate from the University of Florida, is well regarded and respected as a proven real estate associate for over 15 years, broker associate, real estate instructor and Certified International Property Specialist and now Instructor status. She thrives in the international marketplace and is a member of the Tampa Bay Chapter of the Asian Real Estate Association of America. Kelly Lee continues her passion in real estate with certifications in Resort and Second-Home Property Specialist and memberships in the International Consortium of Real Estate Associations. She travels to approximately four countries a year building relationships and sharing listings and information on Florida. In 2017, Kelly Lee traveled with the Asian Real Estate Association throughout Southeast Asia and spoke about Florida real estate in Singapore and in 2018 traveled with Pinellas International Council to Dominican Republic on another real estate trade mission.

Her most valuable attribute is her client commitment. She believes in representing every client with the utmost in professionalism and proficiency. Kelly Lee brings a wealth of experience and current knowledge to all her customers and is dedicated to helping them achieve their goals, being their strongest ally and proven negotiator. As an experienced luxury home, condominium and town home specialist, with proven experience in development, she is currently listing and marketing luxury town homes in 747North, a new downtown development in St. Petersburg. With continual sales in multi-family and commercial, Kelly is aggressive in marketing all properties. Utilizing professional 3D photography,staging, wordsmith copy-writing and all marketing tools through Premier Sotheby’s International Realty, she takes full advantage of her associations with the top brokerage and social media to promote and reach all buyers.

Kelly Lee has lived and enjoys vivaciously the Florida Gulf Coast lifestyle, from growing up on Clearwater Beach to residing in urban downtown St. Petersburg, she shares it all on her “You Tube” channel.  An avid tennis player, golfer and a lifetime spent boating up and down the Florida coast, she understands the Florida legacy. Kelly Lee is also a generous contributor and member of the St. Pete Chamber of Commerce, a dedicated alumna of the 2014 Leadership St. Pete class, social member of the Vinoy Renaissance Hotel, St. Petersburg Yacht Club, and membership chair of Infinity Charity donating time and money to those in need. She is involved with committees that encourage the growth of the community and is a notable board member of the Arts Alliance of St. Petersburg. Preparing to buy or sell your home or property, Kelly Lee McFrederick, as an Accredited Home Staging Professional Master, and past trainer for StagedHomes.com, is passionate and knowledgeable on the Gulf Coast of Florida and is the choice when looking for a real estate professional serving the Gulf Coast.