What is the step-up benefit of a revocable trust from the perspective of the beneficiaries? 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 the short-term and long-term capital gains and the circumstances that generate a taxable event.
U.S. taxpayers are not generally required to pay taxes on the increase in value as it appreciates through the years an asset is held. A capital gain is only realized upon the asset’s sale, resulting in a “gain.” A short-term capital gain is realized when the asset is sold within one calendar year of acquiring the asset, subject to your regular income tax rate. A long term capital gain is realized when an asset is sold after more than a calendar year has passed since the acquisition of the asset. Long term capital gains are generally taxed at a lower rate than most personal income tax rates, mostly 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 tax “basis” for Bob on this asset is $100,000 (the purchase price of the stock). Twenty years later, upon Bob’s death, the stock is now valued at $400,000, but it still has a tax basis of $100,000. When the stock passes to the beneficiaries of the revocable trust it is not considered a “sale” or “gain” from a tax point of view.
Why is the step-up benefit of a revocable trust important? Bob’s beneficiaries are able to take a “step up” in basis, meaning the new basis for the stock asset in our example is $400,000 (not the $100,000 Bob originally 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 taxes until they sell the asset and realize a gain. The actual taxable gain is based upon the growth in the asset’s value above the basis. Let’s say they are able to sell the stock for $700,000 in the present 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 beneficiary sold it was $600,000 ($700,000 sale price less the original purchase price of $100,000).
However, the trust’s beneficiaries do not have to pay capital gains on the total appreciation of the asset over time ($600,000). The step-up benefit of a revocable trust establishes the basis of the asset at the point they acquired it ($400,000). When that asset is sold for $700,000, it generates a taxable capital gain of only $300,000 ($700,000 sale price less the step-up tax basis of $400,000). In this example, Bob has used a revocable trust to give his heirs $300,000 tax-free.
Could a revocable trust provide substantial tax savings for your heirs and beneficiaries? Every situation is unique, and it is important to rely upon the expertise of an experienced estate planning and tax attorney to determine the best strategy for your personal situation.
Janathan Allen and the experienced professionals at Allen Barron help our clients to maximize the benefit of estate planning and revocable trusts for their own life time and for the future of their beneficiaries.
We invite you to learn more about the integrated tax, legal, accounting, estate planning and business consulting services of Allen Barron and contact us or call today to schedule a free consultation at 866-631-3470.
