I continue to get questions on how to calculate the cost basis of farmland or other assets after someone passes away. In almost all cases, the original purchase cost does not matter after the owner’s death.
Normally, when someone dies, the assets owned by that person get a full step up or step down in cost basis to what the property is worth at the time of death. These examples show how this works.
Example No. 1: A single person dies with farmland that is worth more today than at purchase. Farmer Brown buys 500 acres of farmland in 1985 for $500,000. In 2016, he dies. The land is now worth $5 million. His heirs get a step up to $5 million, and they only pay tax on any gain over $5 million.
Example No. 2: A single person dies with farmland that is worth less today than at purchase. Farmer Brown buys land in 2013 for $5 million and dies in 2016. The land is worth $4 million. Heirs who sell it for $5 million owe taxes on $1 million.
Example No. 3: A married couple purchases ground before 1977 and lives in a separate-property state. Farmer Brown purchases land in 1975 for $100,000 and titles it jointly with his wife. He dies in 2015, when the property is worth $5 million. His wife can sell the ground for $5 million and not owe any tax.
Example No. 4: Same as No. 3, but with a twist. Suppose Mrs. Brown dies in 2015. She did not contribute funds to the purchase, so the basis remains at $100,000. If Farmer Brown sells the land for $5 million, he will owe capital-gains taxes on $4.9 million.
Example No. 5: Same as No. 3, only the land purchase occurred after 1976. If Farmer Brown died in 2015, half of the land gets a step up. If Mrs. Brown sells the ground for $5 million, she has a gain of $2.45 million, or half of $5 million plus half of $100,000.
Example No. 6: Same as No. 5, but the couple lives in a community-property state. Affected states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. If Farmer and Mrs. Brown live in one of them, all of the property gets a step up in basis. If either Farmer or Mrs. Brown dies when the land is worth $5 million, the surviving spouse can sell the property for $5 million and owe no tax.
Example No. 7: Land is owned in an LLC, LLP, LP, LLLP or partnership. If farmland is owned in an entity taxed as a partnership, the portion owned by the person who has died can get a step up in value at the partnership level. Assume Farmer Brown owns 50% of an LLC, and his brother owns the other 50%. The partnership can elect to step up half of the land to $2.5 million, which is allocated to Farmer Brown’s heirs. If the partnership sells the ground for $5 million, Farmer Brown’s heirs will not owe capital-gains taxes, while his brother will owe capital-gains taxes on his half of the proceeds.
If the other partner is Farmer Brown’s spouse, check the rules in your state to calculate the final step up.
Example No. 8: Land inside a corporation. When an asset is owned in a corporation, no assets get a step up or down in basis when someone dies. Rather, the stock owned by that person gets the step up or down.
If Farmer Brown owns $5 million of land in a corporation when he dies, the stock gets stepped up to $5 million, less any appropriate discounts for lack of marketability, minority discount or other factors. If heirs sell the land for $5 million and the corporation’s stock basis is $100,000, the corporation will owe taxes on $4.9 million of gain. In an S-corporation, the gain flows through to the heirs, and they will owe the tax.
Ask an Adviser. Each person’s actual facts will be different, and it is extremely important to review this with the appropriate tax adviser.