What if a husband and wife own a home together that increases in value by $500,000. When one spouse dies and the other owns the property themselves, do they receive a step-up in basis? Or do they only receive a $250,000 capital gains exemption when they sell the property?
– Samuel
Your question deals with the rules surrounding both a step-up in basis of an inherited asset and the capital gain exclusion on the sale of a primary residence. These rules are independent of each other, so both are true: the surviving spouse receives a step-up in basis and they only receive a $250,000 exemption. That may sound a little confusing so let’s unpack it below.
If you have similar tax-planning questions or need help managing your investments, consider speaking with a financial advisor to see how they can help.
In finance, the term “basis” generally refers to the amount you pay for something. Basis matters because it’s the starting point from which you calculate taxable gains. For example, assume you buy something for $100,000 – that’s your basis. If the value of the asset grows to $150,000 and you decide to sell it, you’ll owe taxes on the $50,000 capital gain.
A step-up in basis occurs when the basis of an inherited asset is reset to its market value at the time the original (or co-owner’s) owner’s death. In other words, when a person inherits assets like stocks or real estate, the tax basis is adjusted to reflect the asset’s worth at the time of the owner’s passing, rather than the amount initially paid for it.
Returning to the example above, suppose you have an asset with a basis of $100,000, and by the time of your death, its value has increased to $150,000. Instead of inheriting your original basis, your heir receives a “stepped-up” basis. In this case, their new basis is $150,000, and they won’t realize a gain unless the property appreciates further.
(Accounting for the step-up in basis is an important component of tax planning and estate planning. A financial advisor with expertise in either area may be able to help you put this tax loophole to use.)
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The tax code allows you to reduce or avoid capital gains tax on the sale of a primary residence, provided that you’ve lived in it for two of the previous five years. This tax break is known as the Section 121 exclusion.
There are parameters you need to stay within to qualify for this tax break, but the broad strokes are as follows:
