Estate Planning and Probate News

What Are Capital Gains Taxes?

Capital gains taxes apply to the profit made from selling an asset, such as a home, that has appreciated in value. The taxable amount is calculated based on the difference between the property’s original purchase price (known as the basis) and the selling price.

For example, if you purchased a home for $200,000 and your beneficiary sells it for $400,000, the capital gains would be $200,000. Without proper estate planning, this profit could be subject to significant taxation.

The "Step-Up" in Basis

One of the key benefits of inheriting property is the “step-up” in basis. When a beneficiary inherits a home, the basis for calculating capital gains taxes is adjusted to the home’s fair market value at the time of the owner’s death. Using the previous example, if the fair market value of the home is $400,000 at the time of death and the beneficiary sells it for the same amount, there would be no capital gains tax because the basis equals the selling price.

How a Living Trust Preserves the Step-Up in Basis

Placing your home in a living trust ensures that your beneficiary receives the step-up in basis when they inherit the property. A properly drafted revocable living trust treats the home as part of your estate for tax purposes, which means your heirs can take advantage of the step-up provision. This benefit remains intact regardless of whether the property is sold immediately or retained for a future sale.

Risks with a Will or Probate

If you pass your home through a will, the step-up in basis still applies. However, the probate process can create complications and delays that may ultimately cost your beneficiaries:

1. Lengthy Timeline: Probate can take months or even years to complete in Florida, during which the property cannot be sold or easily managed.
2. Increased Costs: Probate involves court fees and legal expenses that reduce the overall value of the estate.
3. Market Fluctuations: Delays in probate may expose the property to changes in the real estate market, potentially decreasing its value and complicating the eventual sale.

Why Probate May Lead to Higher Tax Liabilities

While the step-up in basis applies to property passed through probate, the administrative delays can indirectly increase tax liabilities for your beneficiaries. For example, if the property appreciates further during the probate process, any gains beyond the stepped-up basis could become taxable. A living trust avoids these delays by transferring the property directly to your beneficiaries upon your death.

Avoiding the "Gifted Property" Pitfall

Some homeowners consider gifting their home to their children during their lifetime to avoid probate. However, this strategy eliminates the step-up in basis. When a home is gifted, the recipient inherits the original purchase price as the basis. In the earlier example, if you purchased the home for $200,000 and gifted it to your child, they would owe capital gains taxes on the $200,000 increase in value when they sell the property for $400,000.

By contrast, placing the home in a living trust allows you to retain ownership during your lifetime while preserving the step-up in basis for your beneficiaries.