Comparing two scenarios: Why the step-up in basis matters

As you’ve watched the news about potential tax reform, a principle known as the “step-up in basis” might have caught your attention. Over the years, from time to time, draft legislation has proposed that this principle be changed or eliminated. Although tax law changes to eliminate the step-up in basis are not part of recently-introduced “death tax repeal” legislation, it’s still a good idea to be aware of the potential implications on the charitable giving strategies in your estate plan.

The tax principle of "step-up in basis" means that the cost basis of inherited assets will be reset to their fair market value at the time of the owner's death, effectively erasing any capital gains that accrued during lifetime. You and your advisors might have discussed this principle in deciding which assets to leave to a charity in your estate plan and which assets to leave to your heirs. The implications can be huge. Consider these scenarios:

IRA to kids, stock to charity

If you were to name your children as the beneficiaries of an IRA, and then provide for charitable gifts in your will or trust, your children will pay ordinary income tax on distributions from your IRA following your death. Assets passing under your will or trust, such as appreciated stock, get a step-up in basis, but if a charity is the ultimate beneficiary, it doesn’t really matter because charities are not subject to tax. Tax result? Less than ideal.

IRA to charity, stock to kids

If, instead, you name your fund at Kitsap Community Foundation as the beneficiary of your IRA, KCF pays no income tax. Then, any stock that passes to your children through your will or trust will receive a step-up in basis, meaning your kids can sell the stock and avoid capital gains tax on the appreciation during your lifetime. Tax result? Very good!

Please reach out to Kitsap Community Foundation to learn more about leaving a legacy in your estate plan to support your favorite causes. We are happy to work with you and your advisors to maximize both the community impact and tax efficiency of your charitable gifts.