Know Your “Basis”

When calculating the value of your estate to determine whether or not it will be subject to taxation, you must understand the concept of basis. For most pieces of property that are owned and held, the basis refers to the original cost of the asset. Therefore, in calculating capital gains tax, the taxable gain is determined by the difference between the selling price today and the asset's basis, or original, cost. For example, if you bought a thousand shares of stock for $20,000 and sold it several years later for $30,000, your taxable capital gain would be $10,000.

However, your estate's basis for an asset is calculated according to its fair-market value on the date of your death. Your estate won't have to pay capital-gains tax, but the same type of gain is figured into the total value of your estate (those shares of stock at the now-current value of $30,000).

The present value of your estate could be significantly different from its future basis, notably affecting both you and your heirs. For instance, if you own an asset such as a business or a piece of real estate that‘s appreciated in value during your lifetime, the basis -- its fair-market value calculated at the time of your death -- could push an estate not otherwise subject to taxation over the exempt amount. It’s therefore important to know the value of your estate today and what it’s likely to be worth when you die, to the extent that this can be calculated. Also, basis can help you and your heirs avoid capital gains tax when an asset is sold. This is an important consideration in deciding whether to make an inter vivos (during your lifetime) gift, or pass on a particular piece of property through your estate. Assume, for example, that you have a highly-appreciated asset, such as a home or other building, and you wish to give to your prospective heirs late in your life. If the value of your total estate isn’t large enough to owe federal estate taxes, it might be better to pass the property to them through your estate. In this manner the basis will be the fair-market value at the time of your death. Thus, if your beneficiaries decide to sell the property afterwards, it likely will be subject to far lower capital gains tax.

As a part of your estate planning process, it may be worthwhile to have certain assets appraised, if you suspect that they may have appreciated significantly. The general rule to follow is that an asset's value for gift, estate, and generation-skipping tax (the GST is an additional tax levied on top of the estate tax which is designed to prevent the wealthy from passing on large fortunes directly to their grandchildren, thus skipping the payment of one whole generation’s worth of estate taxes) is its fair market value, which is defined as the agreed-upon price between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having a reasonable knowledge of all relevant facts. Predictably, this value can sometimes be a subject of fantastic disagreement between estate representatives and IRS agents. Occasionally, these disputes over value end up in tax court, with the IRS enjoying a presumption that its valuation is correct. The burden of proof rests with the estate. If your estate is embroiled in a conflict such as this, reports from neutral appraisers could prove very helpful.

You should also consider that if many years pass between the time of an appraisal and the time of your death, the value of your property will likely have changed. If you have assets that are especially valuable or unusual, it may be a prudent to have a new appraisal done periodically, both for estate planning and normal insurance purposes. Be sure to seek the advice of qualified professionals, including an estate planning attorney and a tax accountant, when making decisions concerning your estate planning strategy.