Giving Now Or Later: The Step-Up Rule

About the Author:

Christopher Floss is a Chicago-based attorney who concentrates his practice on estate planning and tax planning matters. He is a regular contributor to this blog, as well as to his blog, Planning Your Future.

Navigating the emotional turmoil which accompanies the death of a loved one is an arduous task in itself. Adding the complexity of the Internal Revenue Code (“Code”) to the scenario does not make it any better, except in this case.

Imagine that your favorite uncle passed away in the current year and left to you in his will 100 shares of Apple stock that he purchased in 1981. If your uncle sold this stock the day prior to his death, he would incur a substantial gain and, as a result, a sizable capital gains tax liability. If you, as his legatee, sold the stock shortly after receiving it from your uncle’s estate, your gain would be either zero or very minimal, depending on the increase of value in the stock from your uncle’s date of death until the day you sell it. How is this possible?

Sec. 1014 of the Code provides the answer to this question. It states:

Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent’s death by such person, be: (1) the fair market value of the property at the date of the decedent’s death, (2) in the case of an election under either section 2032 or section 811(j) of the Internal Revenue Code of 1939 where the decedent died after October 21, 1942, its value at the applicable valuation date prescribed by those sections, (3) in the case of an election under section 2032A, its value determined under such section, or (4) to the extent of the applicability of the exclusion described in section 2031(c), the basis in the hands of the decedent.[1]

Items (2), (3) and (4) of the above-quoted section are beyond the scope of this brief article; however, (1) provides the basis for a major component of the income tax planning that should be accomplished in the estate planning process. This rule is commonly known as the “step-up” rule. Typically, individuals who own highly appreciated assets want to factor this rule into their estate planning by holding these assets during life and allowing them to pass to beneficiaries at death.

The decision to utilize section 1014(a) should not be made in a “tax vacuum.” Other factors, such as the optimization of estate tax planning, the potential to offset recognized gain with carryover losses, and the benefits of donating appreciated items to charity during life should be evaluated when deciding whether to hold onto highly appreciated assets. Tax professionals and estate planners are wise to consider the impact of the step-up rule on an individual’s overall income and estate tax exposure.

[1] I.R.C. § 1014(a).