How does a "step-up" in basis work?

Our law firm recently received this question from one of our clients:

“After my husband passed away in November 2012, I sold the cattle and most of the farm equipment.  I'm now wondering how all will fall out as relates to depreciation.  Of course, the sale price was less than when purchased new. Example: Used 1999 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.”

This is actually a fairly common question.  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.

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 out 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.

Source: www.farmcpatoday.com