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Harnessing the Power of Step-Up in Basis in Retirement
Episode 25126th February 2024 • Secure Your Retirement • Secure Your Retirement
00:00:00 00:14:51

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In this Episode of the Secure Your Retirement Podcast, Radon and Murs discuss how to harness the power of step-up in basis when it comes to inheritance. A basis is the original investment into something and can be a big tax strategy as a step-up in inheritance.

Listen in to learn about the tax advantage inheritors get when capital gains on investments are erased when you pass away. You will also learn the importance of having a conversation with a financial professional to evaluate the risk associated with holding one investment for basis purposes.

In this episode, find out:

  • Basis – your original investment into something and why it’s important when talking about a step-up in inheritance.
  • Step-up in basis – the tax advantage inheritors get when capital gains on investments are erased.
  • Why the step-up in basis could be an excellent wealth transfer strategy for long-term investments.
  • The importance of having a conversation with your financial advisor to evaluate the risk associated with holding one investment.

Tweetable Quotes:

  • Comprehending the concept of step-up in basis holds significant importance in navigating inheritance matters, such as stocks or properties. It can emerge as a strategic consideration even prior to the actual inheritance event.- Murs Tariq


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Radon Stancil:

Welcome to Secure Your Retirement Podcast. Today, we are talking about a topic that is one of those things that you don't have to deal with, but maybe once or twice in life, and that is this idea of a step-up in basis. Now, to give us a little bit of a setting here in order for this to really be something that you would be talking about... Well, I guess there could be a couple of different ways. One, is you might be talking about it from the perspective of, "I just inherited a piece of property. I just inherited a stock." The other one could be, "I own something that's highly appreciated and I would like to be able to get tax efficiency on it." And so, we're going to kind of really talk through the whole concept here, how we come up with what is basis, what does basis mean, and then how do we do the calculation? So I think Murs, if you want, can you just give us a little bit of an idea here just so we understand what we're talking about, what is basis?

Murs Tariq:

Yeah, so basis is a tax term that the IRS and tax people out there just assume everyone understands what that word is. So, I'm going to explain it for you pretty simply here. Basis is your original investment into something. So, let's say you buy a stock, you buy one stock and that stock is $100 for that one stock, it's $100 a share. And so, that is your original investment into the stock. How much that stock grows or goes down, your gain or your loss is going to be calculated against your original investment or your basis into the investment. Go to real estate and say you buy a house for $300,000, that is your original basis into the investment. You bought it for X, and then when it comes time to sell, whether it's gone up or down, with property, typically we see that one going up over time, the math is going to be what did it sell for, minus what did you pay for it? And also there's some nuances with real estate as far as capital improvements and things like that.

But just to keep it simple, what did it sell for and what did you pay for it, what the difference is there is now being explained as your capital gain. And so, understanding your basis I think is very important, especially when we're talking about a step-up in basis when it comes to inheritance issues like inheriting, like Radon said, stock or property. Understanding that even before you inherit can become a big strategy for some, and we will talk about some examples as to why step-up in basis could be a strategy while you are living. But that's the high level of understanding basis. Once you understand that, then I think understanding the step-up is going to make a lot of sense.

Radon Stancil:

Yeah, we have sometimes clients who have... Let's just stick with the property. And it could be a stock as well, but let's just say that you've got this piece of property, let's say make the math simple. I bought it for $100,000. I've owned it for a long time and now it's worth $500,000. That's a $400,000 gain. So, sometimes a person might say, "Well, what if I gift this to my child?" Well, if you gift it to them, they don't get a step-up in basis. That basis carries over to them and then if they sell it, we'll have to pay the taxes on that growth. If I don't give it to them as a gift and then they inherit it, they don't pay any tax on that gain because they get to step-up, so think about stepping up the stairs, I get to step-up to the new basis, which is the value of the property, the value of the stock on the date of inheriting it.

So, go back, I got $100,000 house, it's worth now $400,000. I get to now have $400,000 as my basis. So, now if I inherit it and I got a $400,000 basis, I then hold it for one year and now it's worth $425,000, I have to pay tax on the 25, not on the 400. Anything else on that, Murs, as far as just kind of talking that through?

Murs Tariq:

No, I think that's a good example is the basis... So, you own the house, you could sell it yourself and pay the capital gain to get the cash out of the investment. Or you could say, "We've been in this house. The kids want the house, so let's just hold it until we pass." And now, the kids or the inheritors are going to get a nice tax advantage to where you would potentially pay a couple of hundred thousand dollars of capital gains in this example. That's all going to be erased at your death as it is inherited to the next generation. The capital gains are erased, and they're starting from now what the fair market value is of 300,000.

And say they decide to keep it... I think this is also important to understand. So, the inheritance happens, you bought it for 100, inheritance happens, the basis now goes to 300,000. There are no capital gains in that moment. Now, let's say the kids decide to keep the house that they just inherited and they keep it for 10 years, and now it's worth 500,000. An important distinction here is there are now capital gains to deal with the 300,000 is the inheritance basis for the kids, and it's grown to 500. So, now they've got a $200,000 capital gain if they were to decide to liquidate that investment. So, it's not a fix it forever on taxes, but it is a tremendous advantage if we think through it properly when inheriting or transferring assets.

Another strategy that we hear from time to time from clients is on stock. Let's say you bought a stock. And a very popular one right now is Apple, or Tesla, or Nvidia, those ones, and you bought it for very cheap and it's done well for you. So, maybe you put 100,000 in. And with some of those stocks, they're probably worth 500, 600, 700,000 at this point. Let's just go with 500, right? So, you put $100,000 in and it's worth now 500,000. And you say, "Well, I don't really need this money. Maybe, I'm receiving the dividends off of this stock and that's plenty. That's all I need. And I feel kind of stuck because I can't sell it without realizing a tremendous amount of capital gains."

So, you may say, "As a portion of my strategy on my inheritance strategy, I'm going to say, 'Hey, I believe in...'" The first thing you got to do is believe in this company long, long term because there is risk associated with holding a high level of highly-appreciated stock in your portfolio. But let's say you believe in that company and you just let it ride and hopefully everything works out just fine. And now, that your original $100,000 investment is now a million dollars when you pass away, you have, in all essence evaded, evaded is such a bad word in tax terms, but you've-

Radon Stancil:


Murs Tariq:

Avoided, right? You've avoided the capital gains tax that you would've received if you liquidated any of that stock, and now it goes to them. And now, they've got a million dollar basis of stock. So, it could be a very nice wealth transfer type of strategy. There are pros and cons to it that you have to be aware of when it comes to that type of strategy, but we have seen it and it can work really well if you believe in that stock for the very, very long term.

Radon Stancil:

Yeah. One thing I think about on a stock if I've owned one for a really long time. Some people do what's called dividend reinvesting. And if you do dividend reinvesting, that means every time you get a dividend dividend, you're buying that stock again, but at a new price. So, I might've started buying it when it was really, really low in price, say $50. And then, every time I give a dividend, maybe my next buy is at 55, my next one's at 60, my next one's at 65 and so forth and so on. If I liquidate that stock, I've got to look at what's my basis on each one of those buys, so that I know how much capital gain I got to pay?

The beautiful part is that if I did leave that stock behind and my children were to inherit it or whoever inherited it, they get a step-up in basis. They don't have to worry about all those different trackings. It just goes to the current price. So, if I leave it to them and now the price is $100, that now becomes their new basis. They just have to worry about it from that point. There's a lot of times where it basically comes down to how do we figure out what the basis is? What's the date of death? And it's pretty easy to look that up. Or if it's a piece of property, you might have to say, "Well, what would've been the appraised value at that time of death?" And then, that's kind of what establishes it. And the IRS is pretty easy to work with on that because it's pretty mathematically sound as far as how that works. Anything at all, Murs, that you might think about that a person would consider on this as far as whether to hold something just for the basis or maybe diversifying it because of risk?

Murs Tariq:

Yeah, I think that's a conversation you should always be having with your financial professionals and the team that you work with because there are going to be risks to holding one stock and maybe you bought it at 100,000 and maybe your total portfolio is a million bucks. So, that one stock is 10% of your total portfolio. Well, that may not seem too bad, but let's say that stock has a nice run and all of a sudden it's now worth 20%, 30%, 50% of your portfolio. Well, now you are inherently increasing quite a bit of risk in your portfolio. And the saying of putting all my eggs in one basket, you're putting 50% of your eggs in one basket with the hope that this stock works well.

we do have a tech issue or a:

Radon Stancil:

All right. Well, if you listen to this and you're thinking, "I've got a specific question, a specific thing I'd like to go over," feel free to go to our website, Top right-hand corner, there's a button that says schedule call. We are glad to hop on a call with you and talk through any of your particular situation and see what makes sense, but we'd love to hear from you, so please take advantage of that if you'd like. Also, you can go to our blog page. There's a whole article written on this very topic as well. We hope you have a great week. We'll talk to you again next Monday.



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