How Step Up in Basis Works

Published on: 08:21AM Feb 26, 2013

We received this question from one of our readers yesterday:

"With my husband passing away in October 2012, I have sold the cattle & much of the farm equipment. Now wondering how all will fall out as relates to depreciation. Obviously, the sale price was less than when purchased new. Ex: Used 90 Dump Truck on IRS depreciation @ $7,000 in 2004; had to sell for $1,000 for salvage/parts as repair costs exceeded any greater sales value."

We get questions like this fairly often.  When a person passes away, any assets owned by them will get stepped up to fair market value as of the date of death (or stepped down if the asset is worth less than its adjusted tax basis).  If the asset is owned jointly with their spouse, then in most cases, the half owned by the person passing away will get the step up and the other half will continue to be depreciated by the surviving spouse.

Now for those couples living in a community property state, there is an interesting twist in that both halves get a step-up in basis.  Thus, for taxpayers in those states, they get the double benefit of all assets owned by the community (the deceased spouse and the surviving spouse) getting to adjust their cost basis to fair market value. 

For those assets stepped-up in basis you will begin to depreciate them using the class lives called for by the tax rules (sorry, no bonus depreciation or Section 179).

The nice thing about these rules is that you do not have to go back and try to find our what they originally paid for an asset (if not on the depreciation schedule).  The only documentation required is how you arrived at the fair market value of the asset.

In the example of our reader, even though they paid $7,000 for the Dump Truck and most likely fully depreciated it, they would most likely use $1,000 as their FMV value.  If this is not a community property state, then $500 would be their cost basis since the surviving spouse had fully written down her cost to zero.  In a community property state the basis would be a $1,000 and no gain or loss would be recognized.

Remember that this step-up applies to harvested grain that has not been sold.  If you have sold the grain on a deferred payment contract and have not received the cash yet, this does not get a step-up since it is considered "income"  and income items do not get a step up.