This is the Truth Network. Welcome to Finishing Well, brought to you by CardinalGuide.com. With certified financial planner, Hans Scheil, best-selling author and financial planner helping families finish well for over 40 years. On Finishing Well, we'll examine both biblical and practical knowledge to assist families in finishing well, including discussions on managing Social Security, Medicare, IRAs, long-term care, life insurance, investments, and taxes.
Now, let's get started with Finishing Well. Welcome to Finishing Well with certified financial planner, Hans Scheil, and today's show is Step Up in Basis, which is part of estate planning and has to do with income tax. And I know I had no idea what that word meant, but I bet you're going to be glad you listen to this show, because man, it's another one of those things that really can help you finish well. And so to give you some idea of a Step Up in Basis biblically, I think it's absolutely beautiful in the book of 2 Corinthians 5, verse 17, it says, and I bet you're familiar with this verse.
You may have heard it before. Therefore, if anyone is in Christ, he is a new creation. So, you know, it's really beyond cool that spiritually we receive a Step Up in Basis through Christ. And the idea of that is our value in sin is gone, and our new value in righteousness is now what really counts, right? And so this mirrors how inherited assets receive a new value when they're transferred, which you're going to find out all about in this show. And the more you think about this from the standpoint of what Jesus did for us, you're going to see that as we become a new creation, we get a Step Up in Basis. So the old cost basis is not held against the air, just like in grace.
We are not held accountable for the sins, but we now are a new creation. And when you inherit certain kinds of property that Hans will go into today, you're going to find out wow, I get a Step Up in Basis. Or when you're planning for your heirs to receive your property, certain kinds of property, you're going to find they get that, and the tax ramifications of this are so wonderful that it really helps to be familiar with the term and to be fluent with how Hans can help you with this particular idea. Is what you paid for a capital asset. So if we think about land, and you know, I deal with a lot of farmers, and a lot of farmers inherited their land. So you ask them what they paid for it, I paid nothing because mom and dad owned it. And then I owned it, and then I'm going to give it to my kids.
Well, okay, let's think about that. Now, what is your cost basis? Well, your cost basis is then whatever it was valued at when mom or dad died, whoever it was titled in, or both of them, that the last one of them to die passed it on to you, whatever it was worth, and you had it appraised for in the estate, that is your cost basis.
So you always, when you inherit something, you inherit it at the value it was on the day a person died. Now, if you bought it, if you bought a piece of land, if you paid $100,000 for it, that's your cost basis. And then you can add that any improvements you made. So if you build a fence around it, or you build a road through it, or anything that you did to improve it, that adds to your cost basis.
And the reason cost basis is important is when you sell this thing, let's say we had a piece of land, it was $100,000, we spent $10,000 building the fence, we spent $10,000 building the road, so we had a cost basis of $120,000, and we sold it for $300,000, then we're going to pay capital gains taxes on 180 grand. That's going to be taxable all in one year. So a lot of people get around that by spreading out the sale, and they have the buyer pay the seller over like five years, and then you could spread out the $180,000 capital gain.
Over five years. I personally don't like doing that because I don't like the seller owing me something later that I got to collect. I'd really get my whole 180 grand, but it's not good for taxes.
Because it's going to be stuck all in one year. Okay, so that's cost basis. So what is the step up in basis? Well, if I had the same land, and I didn't sell it, and I died, and it was worth, let's say $400,000 when I died, and I left it to my son. My son, his cost basis would then be $400,000, the value on the day I died. So there's a big incentive for people that own substantially appreciated capital assets like land, or like a rental house, or like a beach house that's gone way up in value to hold it until they die, and then pass it to the next generation, and the next generation inherits it with a cost basis.
At that high value. Does that make sense, Robbie? Yeah, yeah, and again, it's really amazing, you know, that the government did that, but I'm so grateful, like, wow. Especially when you're looking at, like, if you have a farm or something like that, like, for some people, it would cost them the farm literally to inherit it, I guess, which is part of the reason the government did that. So when things are passed in the family, that's the historical basis for the provision, and they've talked about getting rid of this, because it's a lot of rich people that benefit from this, and, you know, they just, they haven't talked in this current tax thing, but over the years, this is up for grabs a number of times, but it's never, it's never gone away to point, and we pretty much plan on it.
Now let's talk about some situations, okay? And they, and, which come up frequently is, a lot of people, their biggest asset is their house, and a lot of retired people who we deal with are retiring people. They've got substantial appreciation in their house, and this is a provision that's about 30 years old, is you can earn a gain of $250,000 on the sale of your principal residence, or you can earn a couple taxes on $250,000, and if it's a couple, it's $500,000. You know, so that means if you pay $200,000 for the house, and you sell it now for $800,000, you would think ordinarily that you'd have a $600,000 gain to deal with, and that's not the case, is that if you've lived there two of the last five years, you're able to exclude $500,000 if you're a couple, and there's only $100,000 of that sale is going to be taxable. Isn't that great?
Wow, yeah, absolutely. And when one of you dies before you sell it, let's just make things even more confusing. So let's say that we got this couple, they chose to live in their house when they retired, they paid $200,000 for it, it's worth $800,000 when the first one of them dies, okay? But she still doesn't sell it. The widow, the surviving widow just stays there. Well, she doesn't owe any tax on anything because she didn't sell it. But sooner or later, she's going to sell it, maybe before she dies, and move somewhere, or downsize, or do something. And her deceased husband, he got a step up in basis on his half of the house. And then, so it gets a little confusing, but this thing splits in half. And so he gets a step up or she gets it because he died. And then on her half, she can use the $250,000 exclusion, okay? And so we deal with this stuff all the time.
And just when people are in here, and they want to, and they had no idea. They just kind of always assumed that they're going to have to pay taxes. And capital gains rates are smaller than ordinary income tax rates.
So a lot of people take safety in that. And it's pretty much 15%. For a couple, up to $600,000 of income, you're going to pay about 15%.
And for a single person, it's up to $533,000 of income. So if this is all bunched up in a year, on the capital gain portion, you're only going to pay 15% to the federal. But then you got state income tax, too. If you're in North Carolina, that's going to be 4% to 5%. You know, if you're in New York or California, that could be over 10%, just for the state income tax. Because most states don't have a capital gains tax.
They just have an ordinary income tax. Right. So I got a lot of stuff to talk about in the second part of the show. I want to go back to the couple, because I've just run into couples where one of the two died. And it's a lot of times their kids bringing them into us.
They're watching our videos, and they're all over the country. And so mom is still in the house, but she's going to sell the house. And she's going to be dealing with that step up and basis business for the half that the husband owned, the deceased husband, the half of the house got to step up and basis. And it gets kind of complicated. If they lived in a community property state, and when he died in a community property state, the whole thing got stepped up in basis from 200,000 to 800,000.
Even only one of them died. And I was just going to read off the community property states for those of you listening around the country. Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin, and Alaska. And those are the community property states. And what it basically means is couples don't own property half and half. They each own the whole thing.
It's kind of complicated to explain, but you can't slice the property in half. And the federal government honors that for step up and basis purposes. So I've had some people like especially in California, where I've helped a widow or widower sell what was the family home that had substantial appreciation, not pay any capital gains tax on any of it, because we stepped up the basis of the whole thing when the first person died. And so, you know, income tax specifically, especially on capital gains and that kind of thing. And so if you go to that particular worry tab, you're going to find them a wonderful video along these same lines, and as well as show notes and charts and the examples that we're going to talk about. And so again, that's at cardinalguide.com, as well as Hans's book, The Complete Cardinal Guide to Planning for the Future. And of course, you know, my favorite, the Contact Hans and Tom page. And so, you know, if you go to cardinalguide.com, it's an amazing resource, especially along these lines to, to get some help from my standpoint, Hans and Tom, to your individual need as you begin to think through what this step up and basis may mean for you, both if you're the one inheriting stuff, or if you're setting up, you know, your estate. So we'll be right back with a look at that.
whole lot more step up in basis. agency. Welcome back to Finishing Well, certified financial planner, Hans Scheil, and today's show, step up in basis estate planning through the income tax idea of what that means, step up in basis. And so, Hans, there's a lot to talk about.
Oh, yeah. So, first example, I'm going to go over this lady called me out of Charlotte, and she was hot. I mean, just, I mean, she was excited about the fact that she had some money in her hand, that she was going to invest with me, and she wanted to find out how to invest it. But before we're going to start doing that, I want to start figuring out how much taxes because she had just sold the condo, that she and her husband owned down in Hilton.
And so they had owned it a long time. And I said, we got to talk about taxes before we start investing money. So, and she was hot about what South Carolina had done to her. When she went to the closing, where, you know, she was paid like $550,000 at the closing was her net. They had withheld like $18,000 worth of South Carolina income tax because South Carolina does that to out-of-state residents because they may never see their money. And so, you know, she was, we started with that, and we worked backwards. And so what I found out is the cost basis in the condo was $110,000. So when we first got started, I mean, she's thinking she's going to have to pay capital gains taxes on 440 grand.
And that's what South Carolina thought too. But when we dig in a little further, her husband died, which I already knew in 2022. So we went on Zillow.
And you can do this and backdated the date to 2022. And the value of that condo was $500,000 the month he died. So we split it in half. $250,000 was his. $250,000 was hers. And his $55,000 basis got stepped up to $250,000. So now we got $250,000. And then you add her $55,000, which is half of $110,000. We were right at $300,000 or $305,000 is her basis. So she's already starting to like this thing.
Okay. And then, you know, so we took the condo that was sold for $550,000 minus the basis of $305,000, $245,000 of it was taxable instead of 440, which was very helpful. And then it was for South Carolina, they have an exclusion built in there that Tom found that of exclusion for people when it's they don't have a lot of money or whatever. We were able to completely get her out of the South Carolina income tax. So she only had to pay 15% on the $245,000, which was 30 some thousand dollars. And it was all due to a step up in basis. So she was very happy when this whole thing was done. And then we started talking to her about selling her big home in Charlotte.
And now we're talking much larger numbers and much more value. And I started to show her how the step up in basis is going to work on his death. And she's already in the process now of selling the house. And what it's really nice is for older people, especially a widow, to be able to get their capital out of their house.
They had no mortgages on anything. So all our wealth was tied up in these two places to get it out of there without a whole bunch of income tax taking a bite off. And it's done through step up in basis. So let me jump on to the next one. I mean, we got this California principal residence.
I hinted at this earlier. And the cost basis was $260,000. And these people came to me in 2024, or 2023 actually. It was the guy and his wife had died in 2018. And so we did the same thing. We took the $260,000 cost basis. And we found the value of the house in 2018 was $1.1 million. It's gone up that much in California. And because California is a community property state, the whole basis stepped up to $1.1 million. And then he sold it for a net $1.6 million in 2024. And he had $1.6 million minus the $1.1 million minus, that's the stepped up basis, minus the $250,000 exclusion for the sale of the principal residence. We only had $250,000 of that that was taxed.
He was real glad he ran into us. Yeah, I'll bet. And a lot of accountants don't really know how to do this stuff. They just kind of take a number from here because they're not thinking about strategic. They're just thinking about calculating tax. And I can't tell you, this guy in particular here and the other one in South Carolina, I had to walk the accountant through this stuff.
And the one in South Carolina, or actually Charlotte, but started arguing with me. And she got moved to another accountant that I took her to that could see things my way. So don't just assume, oh, I leave all this up to my CPA. Well, this is some strategic thinking, taking advantage of two or three rules. One of them being a step up in basis and using them to our advantage.
Right. Which from my standpoint is all the more reason for the contact Tom's and Tom page lately. You've got not only the advantage if you were in this situation, but as you're planning your estate and you know you've got property that you want to go to your heirs. Um, it just makes sense to me that you would, you know, contact Han so that help you plan, right? You know, that your heirs would know about these things because otherwise, you know, all sorts of shenanigans could take place and people miss out on, you know, a huge tax savings. Um, but to have the resources for your heirs to, to know, Hey, when, when this happens, here's who you need to talk to and here's why.
And just having the information out there, like doing this video is invaluable. We have lots of people come into us where their parents have already transferred their house into their names. Well, we have the people themselves transferred into their kids names. And so when that's already done and they had good reasons, a lot of people try to clean up their affairs late and they're just doing all this. They have lost the step up in basis because they're not dead yet.
I mean, they're, they're alive and kicking. And so their kids inherit their same basis or the value of the gift is the basis that the gift, the person sending the gift had. And we've had situations where we've gifted back, you know, we thought the people were going to live longer than a year because if you reverse the gift, then they've got to live a year for that reverse to work. Okay.
Right. I've had situations where people have given property that they own to their parents. Now, this is getting a little dicey, but I mean, some people really work this thing to the fullest.
I've never done this for a client. So say you have a guy about my age and say he has a young mother and, you know, we're young, you know, he's got a baby. And relative to my age, let's say she's 84 and she's in good health. So I could take an appreciated piece of property, gift it to mom. And then if she lives a year and then she gives it back to me when she dies, it gets a stepped up basis when she dies. So for the people that really like to play games, this thing is ripe with opportunities. So, right. Well, it's not just, you know, it's just an opportunity again, I think, to take advantage of wisdom and understanding of how the task laws really work, what they were set up to do. And, you know, these things were meant so that people would be able to transfer large pieces of property, et cetera, without their heirs just not being able to pay the taxes and that kind of thing. I think it's really important.
It's absolutely beautiful and so helpful. Well, I'm going to tell you one place you're going to see this in your neighborhood, really anybody that's listening. If you live in a city like Raleigh or Greensboro or Winston-Salem or Charlotte and you live out toward the suburbs, you got areas where you drive by the subdivision, you know, new subdivision and there's homes that the lots were at least $100,000, you know, and you got nothing but homes. And then you go about a half a mile down the road and you got a fence and you got cows in there grazing.
Okay. And you say, what's up with that? And you got this old farmhouse and you're thinking, well, why didn't this guy sell the property to the developers?
I mean, he's just, it's just sitting there. And what I'm going to tell you is his kids will, but he's sitting on it and the cows are out there because he doesn't want to pay the property taxes like the people in the subdivision. So he gets a farm reduction by actually using it as a farm. So that's why the cows are in the city. And then when he passes away, he wills it to his kids. They get a gigantic step up in basis and then they sell it to the developers and they live happily ever after. Except the cows.
Except the cows. They have to move on. Yeah, that's funny. But yeah, that's, you know, you can't help but wonder that when you see those, it's exactly what's going on.
But again, it's a great strategy and a way to finish well. And so this is a good time to remind you, of course, that this show is brought to you by Cardinal Guide, cardinalguide.com. And if you go to cardinalguide.com, you're going to see these menus or seven worries tabs. And if you click on one of those tabs, one of those is going to be income and income tax, excuse me. And when you look at income tax, you know, one of the big things is capital gains.
And so this is a whole explanation of this. And there's going to be a video right along these same lines called step up in basis that has examples, show notes, all sorts of information, videos, all kind of videos on this idea of income tax there at cardinalguide.com. And of course, if you go there, you're going to find Hans's book, which also has this idea in it, which is the complete cardinal guide to planning for and living in retirement. And of course, the all famous because I'm sure like me, you're thinking this is more than I want to try at home. That's the contact Hans and Tom page because they do understand it and understand how it may fit into your situation.
Is it certainly not a cookie cutter idea? And so it's all there at cardinalguide.com. Thanks, Hans. Great show. Thank you.
And God bless you. God bless the opinions expressed by Hans Scheil and guests on this show or their own and do not reflect the opinions of this radio station. Take into account your specific situation or objectives and is not intended as recommendations appropriate for you before acting on any information mentioned. Please consult with a qualified tax or investment advisor to determine if it's suitable for your specific situation. Finishing well is designed to provide accurate and authoritative information with regard to the subject covered investment advisory services offered through Brookstone Capital Management LLC, abbreviated BCM, a registered investment advisor. BCM and Cardinal Advisors are independent of each other.
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