The nuances of inheritance tax are difficult and complex. They require familiarity and expertise in an area of law that shifts and evolves every year. One of those areas that can be difficult to understand is the step-up costs involved in estate plans and inheritance taxes.
What are stepped-up costs and how are they taxed?
Step-ups in cost describe an asset’s change in value during the buyer’s lifetime. This is an important value to calculate, as it is not subject to capital gains tax after the buyer’s death. Likewise, you will not have to pay the capital gains tax if you sell the asset soon after (and at the same value) you inherited it.
Over the years, commercial or rental property owners can write off depreciation of the value of their property. The stepped-up cost basis also eliminates the need to collect depreciation taxes. If you inherit the building, this process restarts. You are not taxed on its previous depreciation.
What about an irrevocable trust?
Many people would like to reduce future estate taxes and avoid probate. Trusts can help you do this. However, this is not necessarily the case with assets in an irrevocable trust.
When you inherit assets through an irrevocable trust, they are a gift. As a result, authorities will tax you based on the gains that happened throughout the deceased person’s lifetime, plus any depreciation they wrote off, when you decide to sell it.
Obviously, this could cause more problems than solutions. Instead, you might consider a revocable living trust. This arrangement can help you avoid probate and avoid other taxes.