Historically, estate-planning professionals had a simple goal when it came to estate tax planning: to shift as much as possible out of their clients’ gross estate in order to reduce or limit the exposure to estate tax. However, in light of the higher federal income tax rates, estate planners must now focus on the type of assets owned by their clients (e.g., cash, marketable securities, real estate, closely held businesses) and inquire regarding the tax basis of each asset.

Capital Basis Adjustment

The Capital Basis Adjustment, also known as the step-up (or possible step-down) in basis eliminates the recognition of gain (or loss) on the appreciation (or depreciation) of the asset from the date it was acquired by the decedent to the date of the decedent’s death.

Carryover Basis v. Stepped Up Basis

In general, when an individual gifts an asset during life, the basis in the asset in the hands of the donee is the lower of cost or fair market value at the time of the transfer.  Alternatively, when an individual dies, the tax basis of the assets owned by the decedent receive a “step-up” in basis at death to the asset’s then-fair market value. Therefore, upon the death of an individual, the recipient receives the asset with a “stepped-up basis.” As a result, after reviewing each asset and its tax basis, the estate planner and the client may well determine that certain assets should remain in the client’s gross estate in order to receive the step-up in basis at death. When formulating an estate plan, it is now common for the income tax analysis to trump the estate tax concerns of the client.