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The Step Up Advantage of a Revocable Trust

What is the step up advantage of a revocable trust here in California?  How can a revocable trust not only pass money and assets to your beneficiaries but save a substantial amount of tax in the process?  The answer lies in an understanding of short term and long term capital gains, and what generates a taxable event.

US taxpayers are not generally required to pay tax through the years as an asset appreciates.  A capital gain is only realized upon the sale of the asset resulting in a “gain.”  A short term capital gain is realized within one calendar year of acquiring an asset, subject to your normal income tax rate.  A long term capital gain is realized after a period of more than a calendar year has passed since the acquisition of an asset.  Capital gains are generally taxed at a lower rate than most personal income tax rates, between 15% and 20%.

Let’s say a person named “Bob” sets up a revocable trust for the benefit of his heirs, loved ones and cherished institutions.  The assets placed within a revocable or living trust pass to the beneficiaries upon Bob’s passing.  For this example, let’s assume Bob purchases stock for $100,000 and places it into the trust.  The “basis” for this asset is $100,000 (the purchase price of the stock).  20 years later, upon Bob’s death the stock is now valued at $400,000 but it still has a basis of $100,000.  When the stock passes to the beneficiaries of the trust it is not considered a “sale” or “gain” from a tax point of view.

Why is this important?  Bob’s beneficiaries are able to take a “step up” in basis, meaning the new basis for the stock asset is $400,000 (not the $100,000 which Bob paid when he acquired it).

Now the beneficiaries have received the full value of the stock or $400,000 which becomes the “basis” for those beneficiaries.  They are not required to pay tax until they sell the asset and realize a gain.  The gain is based upon the growth in the value of the asset above the basis.  Let’s say they are able to sell the stock for $700,000 in this bull market.  The taxable amount of the gain would be $300,000 or the difference between the sale price and the new “basis” of the asset.  In this example, the growth of a $100,000 asset between the time Bob purchased it and the time the beneficiary sold it was $600,000 ($700,000 sale price less the original purchase price of $100,000).  However, the beneficiaries of the trust do not have to pay capital gains on the total appreciation of the asset over time ($600,000).  The basis of the asset when they acquired it was $400,000 and when it is sold at $700,000 it generates a taxable capital gain of only $300,000.  Bob has used a revocable trust to give his heirs $300,000 tax free in this example.  This is the step up advantage of a revocable trust for estate planning.

Janathan Allen and the experienced professionals at Allen Barron help our clients to maximize the benefit of estate planning and trusts for their own life time and for the future of their beneficiaries.  Our integrated tax, legal and accounting services makes it easy to get sound advice from a much broader perspective so that you may make informed financial, tax and estate planning decisions.  We invite you to contact us for a free consultation at 866-631-3470 to learn more about creating or updating your estate plan.