Every piece of property an individual owns has a basis used in calculating capital gains on a sale of property. So, an executor must understand the special rules related to capital gains on estate or inherited property. The stepped-up basis rule is an important rule the executor needs to understand.

Capital Gains and the Stepped-Up Basis Rule

The stepped-up basis rule sets the basis of the decedent’s property at the fair market value on the date of death. Applying the stepped-up basis rule works as follows:

1) The decedent bought a house for $100,000.00, and at the date of death, the house value was $300,000.00. A day after the death of the decedent, a beneficiary who inherited the house, sold the house for $300,000.00. There is no gain on the sale because the beneficiary received a stepped-up basis from $100,000.00 to $300,000.00 at the date of death. If the beneficiary held onto the house while it appreciated in value and later sold the house for $320,000.00, the beneficiary would have to pay a capital gain tax on the $20,000.00 profit.

2) The decedent owned 5000 shares of ABC stock with a cost basis of $10.00/share. On the date of death the average price of the stock (the average of the low price of the trading day and the highest price of the trading day) was $20.00/share. The original basis of the stock was $50,000.00 which appreciated to $100,000.00 at the date of death. If the beneficiary elected to sell the stock at the same price of $20.00/share, the stepped-up basis rule would eliminate any gain on the sale. However, if the beneficiary decided to hold the stock and sold it later at $22.00/share for $110.000.00, then the beneficiary would have to pay a capital gain tax on the $10,000.00 profit.

A quick note: If the decedent died on a weekend or a holiday, the stepped-up basis for a sale on a stock would be the average price on the prior business day.

Capital Gains for Large Estates

For large estates that will owe estate taxes, the executor can opt for the alternate valuation date. The alternate valuation date determines the basis of property in the following ways:

1) The alternate valuation date will set the basis at the fair market value of the property 6 months after the date of death.

2) If the distribution of property occurred before 6 months, the fair market value of the property on the date of distribution is the new basis.

Conclusion

Basically, absent a federal estate tax return filing, the stepped-up basis rule will set the basis of the property.  However, there are special rules for deaths that occurred in 2010 in determining basis. So for this reason, an executor may retain a tax professional to deal with the complexities.

Although an executor may outsource filing the returns, there are three reasons why an executor should know how to determine the basis of property: 

1) If a beneficiary held inherited property and sold years later, the beneficiary needs to know the basis of the property. Furthermore, the beneficiary may call years later to get the basis of the property. Therefore, the executor, while settling the estate, should volunteer this information to the beneficiary.

2) For large estates, the executor decides which rule to use: the stepped-up basis rule or the alternate valuation date. A tax professional will guide the executor through the decision, but the executor will still need to understand each rule.

3) Executors are responsible for the accuracy of the returns. So, if the executor sold estate property, the executor needs to know the basis of the property.

For more on determining the basis of assets, refer to the IRS Publication 551 Basis of Assets.

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