Stepped-up Basis

For the Asset You Now Own

The General Rule

If someone has sold an asset on an installment contract and that person’s death occurs while any amount remains owing on the installment contract, the death will not cause the tax basis in the asset that was sold to be “stepped up” under Section 1014 of the Internal Revenue Code. Under that section, the step-up in basis is not available for assets that were “sold, exchanged or otherwise disposed of before the decedent’s death”. In the case of an installment sale before death, the asset that was sold on the installment contract was indeed “sold, exchanged or otherwise disposed of before the decedent’s death”.

Nevertheless, if you don’t plan on dying right away, it makes little sense to pay a tax now which can be deferred for a lengthy period of time with a collateralized installment sale, because for every year in which the deferral continues the effective rate of the tax declines in terms of its cost in today’s dollars. Deferral of a tax for 20 years, for example, can be the equivalent of an 80% or more reduction in the rate of the tax, because of the money that can be earned from investing the dollars that otherwise would be paid now in taxes, and because of the depreciating value of the dollar.

Further, the tax on the gain isn’t the only consideration. Under present law, the full burden of the 55% federal estate tax will return after 2010. It may be more advantageous in your circumstances to sell now with a collateralized installment sale so that your estate can discount the value of the collateralized installment sale contract for estate tax purposes, rather than have to face a 55% tax on the full value of the appreciated asset.

For the Asset You Plan to Acquire

When you sell an asset on a collateralized installment contract, you may use the income stream from the installment payments to leverage your way into a replacement asset, if you so choose. If you do so, you achieve a new, stepped-up basis in the replacement asset for depreciation purposes–now, instead of waiting for death.

While the collateral remains in place, you may, if you wish, use the income stream from our contract with you as an asset to justify other borrowing at any time—including, if desired, for the purchase of one or more other assets without time restrictions or pressure. That way, the collateralized installment sale permits you to accomplish both tax deferral of the tax on the gain on the sale of your original asset and the acquisition of a new asset with a stepped-up basis for depreciation purposes.

Seek Competent Advice

These are complex questions. Seek competent legal and tax advice. We can suggest factors for consideration, as we have above, but you should have legal and tax advice for your particular situation.