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What is Basis and Why is it Important?

Estate Planning

What is Basis and Why is it Important?

by Nathan Russell, Owner & Managing Attorney

I really enjoy estate planning as it affords me the opportunity to really dig into my client’s goals.  This allows me to ask a various list of questions of my clients and, in return, provide a lot of insight into their estate planning concerns and goals.  As an estate planner, one of the most common concepts I have to explain to clients is the term “Basis”. “Basis” is a term used to describe the cost or original value of an investment or asset for tax purposes. It is essentially the amount used to calculate capital gains or losses when an asset is sold. The basis can be adjusted to reflect changes in value, such as improvements made to real estate or stock dividends. When a client sells an asset, their capital gain or loss is determined by subtracting the basis from the sale price of the asset. It is important to accurately determine the basis of an asset to correctly calculate taxes owed on any profits from a sale.

Improvements Can Modify Basis

While your basis in an item is generally determined at the time of purchase it can be modified.

Specifically, improvements to an asset can impact the basis in the following ways:

  1. Capital Improvements: Capital improvements are permanent additions or alterations to a property that increase its value, extend its useful life, or adapt it to a new use. Examples include adding a room, installing a new roof, or updating a bathroom. These improvements increase the basis of the property.
  2. Repairs: Repairs are expenditures made to keep an asset in good condition and maintain its value. Examples include fixing a leaky roof or replacing a broken window. Repairs do not increase the basis of the property, but they can be deducted from current year income.

It’s important to note that to qualify as a capital improvement or repair, the expenses must be ordinary, necessary and reasonable in amount, and incurred in connection with the property. Additionally, documentation should be kept supporting the expenses as either a repair or a capital improvement.

What Does Stepped-Up Basis Mean?

When drafting estate plans, it is critical to determine if you should utilize a “stepped-up basis” plan.  “Stepped-up basis” is a tax term used to describe the adjustment of the cost basis of an asset for tax purposes upon the death of an owner. The stepped-up basis is equal to the fair market value of the asset at the time of the owner’s death. This means that, for tax purposes, the person inheriting the asset can treat the asset as if they had purchased it for its fair market value at the time of the owner’s death.  The fair market value is often determined by the public market for stocks and bonds while an appraisal is generally necessary for real estate and business assets.

For example, if an individual owns stock worth $100,000 at the time of their death and their cost basis in the stock was $50,000, the person inheriting the stock would receive a stepped-up basis of $100,000. This would effectively eliminate any capital gain that would have been recognized if the stock had been sold for $100,000 while the original owner was still alive.

The stepped-up basis can have significant tax implications for the person inheriting the asset, as it can reduce the amount of capital gains tax they would owe if they sold the asset in the future. It’s important to note that not all assets are eligible for a stepped-up basis and that the specific rules and regulations vary depending on the type of asset and jurisdiction.

In general, in Wisconsin, if an asset is considered marital property, the surviving spouse generally receives a stepped-up basis for the entire property upon the passing of the spouse. Marital property is generally defined as property acquired during the marriage, regardless of which spouse holds title to the property.

Upon the death of one spouse, the surviving spouse typically receives a stepped-up basis equal to the fair market value of the property at the time of death. This means that, for tax purposes, the surviving spouse can treat the entire property as if they had purchased it for its fair market value at the time of the deceased spouse’s death.

It’s important to note that this stepped-up basis only applies to marital property. Any separate property that was owned by one spouse prior to the marriage or acquired during the marriage through gifts or inheritance would not be eligible for a stepped-up basis.

Basis and Gifting an Asset

When you give an asset, such as stock or real estate, to your child, the child’s basis in the asset is generally the same as your adjusted cost basis in the asset immediately prior to the gift. This means that if you bought the asset for $100 and its value has increased to $200, your child’s basis in the asset would be $100.

It’s important to note that there may be gift tax consequences if the value of the asset you give exceeds the annual gift tax exclusion amount, which is currently $17,000 per recipient for the year 2023. Additionally, if you give an asset that has declined in value, it may be beneficial to transfer the asset to your child rather than selling it, as the child would then inherit your lower basis in the asset.

In conclusion, understanding the concept of basis is crucial in estate planning and in calculating taxes owed on asset sales. It is important to accurately determine the basis of an asset, which can be adjusted through capital improvements or repairs. The stepped-up basis is a tax tool that we can use to save significantly on taxes for the person inheriting the asset. Estate planning requires careful consideration of all these factors to ensure a smooth transfer of assets and minimize tax liability.  The attorneys at Russell Law Offices, SC are experienced and knowledgeable in the areas of tax basis to help you weave its consideration into your estate plan.  Call for a consultation today!


Nathan Russell

Managing Attorney and Owner

All Locations

About Nathan Russell is the founder and owner of Russell Law Offices, SC.  Born and raised on his family’s fifth generation dairy and crop farm in Shullsburg, he returned to Southwest Wisconsin to practice law in 2009.    Nathan earned a degree in Agricultural Economics and his Juris Doctorate from UW-Madison.  Prior to opening Russell […]

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