The cost basis calculation helps determine the taxes owed in states with an inheritance tax. The value of inherited assets is calculated based on cost basis. Most estates are too small to be charged the state or federal estate tax, which applies only if the deceased person's assets are worth $13.61 million in 2024. As of 2024, twelve states plus the District of Columbia levy an estate tax, while six levy inheritance taxes.
Key Takeaways
- The cost-basis figure usually equals the fair market value when the estate owner dies or the assets are transferred.
- A "step-up" basis means the cost basis is raised to the asset's market value on the original owner's date of death for tax purposes.
- As of 2024, twelve states plus the District of Columbia levy an estate tax, while six levy inheritance taxes.
Determining Cost Basis
The cost basis represents the original value used for tax purposes when calculating capital gains on assets.
- Fair Market Value: The cost basis may equal the fair market value (FMV) of the property or asset at the time of the decedent's death or when the actual transfer of assets was made.Fair market value is the price that a property or an asset would command in the marketplace, given that some buyers and sellers know about the asset and that a reasonable period is available for the transaction.
- Alternative Valuation Date: If the value of the assets has dropped since the date of death or their transfer, the estate administrator can decide to use an alternate valuation date for the estate. This extends the valuation to six months after the date of death. Under estate law, the estate's value must have dropped within six months to choose this option.
A "step-up" basis resets the cost basis of an appreciated inherited asset for tax purposes, where the cost basis is raised to the asset's market value on the prior owner's date of death, reducing future capital gains taxes. This provision applies to financial assets like stocks, bonds, mutual funds, and real estate.
Capital Gains Tax
Those who sell inherited assets may have a tax liability based on capital gains. No matter how long property or assets are held, either by the decedent or the inheriting party, an inherited property is considered to have a holding period greater than one year.
That means capital gains or losses are designated long-term capital gains or losses for tax purposes. Even if assets are sold immediately, beneficiaries avoid the less favorable treatment typically given to assets held for less than a year, and taxed at the normal income tax rate.
Estate Tax by State
Estate taxes are calculated by totaling the value of the deceased individual's assets. If the value does not exceed the state or federal exemption of $13.61 million, estate taxes are not levied. As of 2024, thirteen states, including the District of Columbia, levy estate taxes based on the total value of the estate:
- Connecticut: $13,610,000
- District of Columbia: $4,710,000
- Hawaii: $5,490,000
- Illinois: $4,000,000
- Maine: $6,410,000
- Maryland: $5,000,000
- Massachusetts: $2,000,000
- Minnesota: $3,000,000
- New York: $6,940,000
- Oregon: $1,000,000
- Rhode Island: $1,774,583
- Vermont: $5,000,000
- Washington: $2,193,000
Inheritance Tax by State
An inheritance tax is a percentage of the overall value of the inheritance, collected from the beneficiary. The thresholds at which inheritance tax kicks in and the rates charged typically vary by the relationship to the decedent.
Even in states with an inheritance tax, family members are typically spared from tax, particularly if it's a relatively small inheritance. As of 2024, six states that collect aninheritance tax include:
- Iowa
- Kentucky
- Maryland
- Nebraska
- New Jersey
- Pennsylvania
What Is a Disadvantage of Choosing an Alternative Valuation Date?
The timing must apply to all of the inheritance and assets. The lower valuation it creates will form the basis for any capital gains incurred in the future, and beneficiaries may be subject to a larger tax bill for capital gains than if they had chosen a higher valuation when they inherited the assets. Some exceptions to these valuation rules may apply to assets related to farming or a closely held business.
What Is the Cost Basis of Inherited Stock Shares?
If an individual inherits stock, its cost basis is "stepped up" to the value of the security, at the date of the inheritance. Step-up in basis is the adjustment in the cost basis of an inherited asset to its fair market value on the date of the decedent's death.
How Is Cost Basis Determined for Intangible Assets?
The cost basis of intangible assets like patents, copyrights, or trademarks is usually the cost to buy or create them.
The Bottom Line
The cost basis of an asset often helps determine the taxes a beneficiary will pay when they inherit the asset. For tangible assets, the cost basis is commonly "stepped up" and based on the original owner's date of death. Death taxes, or estate plus inheritance taxes, can be levied at the federal and state levels.
