Obtaining the Highest Step-Up Possible

Obtaining the Highest Step-Up Possible

The Obtaining the Highest Step-Up Possible Even if the above IRS valuation requirements sound extensive and burdensome, they really are not. Almost all of the requirements are traditionally included in a standard professional property appraisal, and in most cases that is all you need to support your requested stepped-up basis value.

All appraisers, however, are not alike. Anyone in the real estate industry will tell you there can be a significant difference in appraised values on a given piece of real estate. Even in stable market conditions, it is not unusual to find appraisals differing as much as 20 to 25 percent, and that variable can make a huge difference in how much you’ll pay in taxes.

Example:
Betty and Hal had been married for 30 years when Hal died. Hal had left everything to Betty, including their California home and a sizable piece of vacant land. At the time of Hal’s death 10 years ago, the real estate market was booming, but the market had slowed down the year after he died, and prices had declined about 30 percent
on average. Betty really wasn’t aware of the downturn in the real estate market because she had no interest in selling. Recently, however, she has decided to move out of state to be near her daughter and grandchildren. Luckily, Betty’s timing is good because the real estate cycle has come full circle, and market values in her area have climbed back to the previous highs of 10 years ago. Betty’s home has a current market value of approximately $450,000, and she has recently been offered $400,000 for the vacant land. Both properties were bought almost 40 years ago—$30,000 for the home and $20,000 for the land. Betty has decided to sell both properties.

If Betty’s advisors fail to tell her about filing for the stepped-up basis on these properties, she will face taxes on the approximate $170,000 gain on her home ($450,000 sales price less the $250,000 primary home exemption less the $30,000 original cost basis) and another $380,000 gain on the sale of the land ($400,000 sales price less the $20,000 basis). Combined, Betty’s gain would be $550,000 and her tax liability approximately $159,000 (20 percent federal and 9 percent to California).

Assuming Betty has good advisors and files for the available step-up in basis, however, her tax situation will depend on how the properties were vested and how she inherited them. If both properties were held in either community property or in a revocable living trust as community or marital property, Betty will be able to file for a full stepped-up basis on each. Because the properties were inherited 10 years ago and the example states that the current values have “climbed back to the
highs of 10 years ago,” an appraisal of each property as of Hal’s date of death (also 10 years ago) should qualify Betty for a full basis step-up to today’s values.
Presuming valid appraisals did support a step-up to the current values, she could sell both properties and have no taxable gain at all. Even if the properties were both held in Hal and Betty’s name as “husband and wife as joint tenants,” Betty would still be entitled to a stepped-up basis but only on one-half (Hal’s half) of each property.

If held as joint tenants, her basis on the home would be approximately $240,000 (Hal’s half stepped-up to $225,000 plus Betty’s half at her original $15,000). After the step-up there would be no tax liability on the sale of the home because the $250,000 primary residence exemption would shield Betty’s $210,000 gain. On the land, however, there will be taxes. Betty’s new basis would be $210,000 (Hal’s half stepped-up to $200,000 plus Betty’s half at her original $10,000), and the gain on the sale would be $190,000 with a tax liability of approximately $53,100 (20 percent federal and 9 percent to California).

All of the calculations above presume one crucial factor: a supporting appraisal that shows the property values on Hal’s date of death are approximately equal to today’s market values. The example also presumes that a real estate market downturn had occurred between the date of death and the sale of the properties. Even had there been no downturn, a favorable appraisal to support a higher stepped-up basis would save a lot on taxes. Considering the 20 to 25 percent variation commonly seen between appraisers, which one you pick can either save you or cost you a lot. In the example above, both of Betty’s properties had a combined $950,000 estimated date-of-death value. If an overly conservative appraiser’s valuation came in at 25 percent lower, it might cost Betty tens of thousands in additional capital gains taxes.

Some appraisers are naturally more conservative than others. In addition, an appraiser’s level of conservativeness may vary dramatically depending on the purpose and use of the requested appraisal. Although not discussed often, a common practice is to look for the most favorable appraiser—in other words, to “shop” appraisers. Real estate agents do it, mortgage brokers do it, and attorneys do it, so it should be no surprise that the IRS also uses its “favored” appraisers in a dispute.

If you are going to file for a stepped-up basis either because it is time to sell or to gain a basis advantage on a property you intend to keep a while, you might try to tap into any professional real estate resources you have. Real estate agents, mortgage brokers, and real estate attorneys may have established relationships with appraisers, so if you can use their existing relationships, do so. If you were to simply start calling appraisers from directory listings, they might take offense if you “suggest” a particular outcome for the appraisal; that same suggestion between industry professionals, however, would not be unusual nor draw criticism.