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What to know about the effect of capital gains tax on your heirs

On Behalf of | Jun 24, 2024 | Estate Planning

 If you’re beginning the estate planning process or possibly considering some modifications to your existing plan, one of your concerns is likely the tax ramifications of your decisions on the value of your estate (and, by extension, your beneficiaries). That’s why people with high-value estates strategize to lower, if not eliminate, estate taxes.

It’s also important to consider possible tax ramifications to individual heirs and other beneficiaries. One concern that many people have is whether their loved ones will be saddled with capital gains tax on assets that have increased significantly in value since they were purchased.

Here in California, real estate is an obvious example. Say you bought your home 30 years ago for $500,000 and that today, homes in your neighborhood are selling for at least $2 million. If you leave the home to your adult child (even if you assume they’ll sell it rather than live in it), will they be stuck paying capital gains tax on $1.5 million? 

 First, it’s important to understand that capital gains tax doesn’t come into play until an asset is sold. If they assume ownership of it and hold onto it, it doesn’t matter how much it increased in value over the years.

Understanding the “stepped-up basis” rule

When they sell it, however, the IRS’s “stepped-up basis” rule would apply. That means the capital gain on the home would only be the amount it increased in value (if it did) between the time they inherited it and the time they sold it. That would likely be considerably less. Further, the IRS allows a $250,000 exemption ($500,000 for couples) on capital gains. If they sold it immediately, there would be virtually no capital gains.

The same rule applies to any inherited. This is why it’s critical for those who inherit property or anything with a value that rises rather than declines over time to get a valuation of it for their records.

Considering how inherited assets will impact your loved ones – both financially and in other ways – is an important part of mindful estate planning. Having experienced financial, tax and estate planning guidance can help you make the best decisions.