Understanding Step-Up in Basis for Inherited Real Estate in North Carolina

When a loved one passes away, dealing with their estate can be emotionally and financially complex. One key tax benefit that often comes into play is the "step-up in basis," which can significantly reduce capital gains taxes for heirs or devisees when they eventually sell inherited property. This is particularly relevant for real estate in North Carolina, where property values have been on the rise in many areas. In this post, we'll break down what step-up in basis means, the different ways heirs or devisees can receive it upon a decedent's death, and some important considerations to keep in mind.

What Is Step-Up in Basis?

Simply put, a property's "basis" refers to its original cost for tax purposes, adjusted over time for factors such as improvements or depreciation. When you sell a property, you pay capital gains tax on the difference between the sale price and your basis. However, under federal tax law (Internal Revenue Code Section 1014), inherited assets like real estate get a "step-up" in basis to their fair market value (FMV) at the date of the decedent's death. This resets the clock on gains, potentially wiping out taxes on appreciation that occurred during the decedent's lifetime.

For example, if a parent bought a house for $100,000 decades ago and it's worth $500,000 at their death, the heir's new basis is $500,000. If the heir sells it for $510,000 shortly after, they only owe taxes on the $10,000 of gain—not the full $410,000.

This rule is federal, so it applies nationwide, including in North Carolina. However, state-specific factors like property ownership laws can influence how it works.

Ways Heirs or Devisees Can Receive a Step-Up in Basis

The step-up generally applies to assets included in the decedent's gross estate for federal estate tax purposes. Here's how it plays out in common scenarios for real estate in North Carolina:

1. Inheritance Through Probate (Via Will or Intestacy)

In North Carolina, real estate typically passes outside of probate directly to the devisees (named in a will) or heirs (under intestacy laws if there's no will), unless the will devises the property directly to the estate. Regardless of whether the property passes through full probate administration or outside of probate, the recipients receive the property with a full step-up in basis to the FMV at death. This is straightforward and ensures the entire property benefits from the reset. However, even when passing outside full probate, probating the will is often necessary to clear title, and the process can involve court costs and delays if administration is required.

2. Through a Revocable Living Trust

Many people use revocable living trusts to avoid probate. If the decedent transferred the real estate into such a trust during their lifetime, the assets are still considered part of their estate for tax purposes because the trust is revocable (they retained control). Upon death, beneficiaries receive the property with a full step-up in basis, just like in probate.

This is a popular estate planning tool in North Carolina because it streamlines transfer while preserving the tax benefit. However, the trust must be properly funded (title transferred to the trust) for this to work.

3. Joint Tenancy with Right of Survivorship

If the property is held in joint tenancy (common for non-spouses, like siblings), the surviving joint tenant automatically inherits the decedent's share upon death, bypassing probate. The step-up applies only to the decedent's portion of the property—typically 50% if ownership is equal. The survivor's original basis remains unchanged for their share.

For instance, if two siblings bought a property for $200,000 (each with a $100,000 basis) and it's worth $400,000 at one sibling's death, the survivor gets a step-up to $200,000 for the decedent's half. Their new total basis is $100,000 (original) + $200,000 (stepped-up) = $300,000.

North Carolina recognizes joint tenancy, making this a viable option for co-owners who want automatic survivorship.

4. Tenancy by the Entirety (For Married Couples)

In North Carolina, married couples can hold real estate as tenants by the entirety, a special form of joint ownership that offers creditor protection and automatic survivorship. Upon one spouse's death, the survivor becomes the sole owner.

Since North Carolina is a common law property state (not community property), the step-up typically applies only to the decedent's half of the basis. This is similar to joint tenancy but exclusive to spouses.

This ownership type is common for primary residences and can simplify inheritance, but it means no full double step-up like in some other states.

When Step-Up Might Not Apply: Irrevocable Trusts and Other Scenarios

Not all transfers qualify. For example, if the property is in an irrevocable trust that's not includible in the decedent's estate (common for asset protection or Medicaid planning), there's generally no step-up in basis. The beneficiaries inherit the original basis, potentially leading to higher taxes on sale.

Also, note that North Carolina does not allow transfer-on-death (TOD) deeds for real estate, so you can't use that to bypass probate while getting a step-up (though TOD works for other assets like accounts).

Gifts made before death don't qualify either—the recipient takes the donor's original basis (a "carryover" basis), which could result in larger gains.

Important Notes to Consider

While step-up in basis is a powerful tool, here are some key points to keep in mind:

• Appraisals Are Crucial: To establish the FMV at death, get a professional appraisal. This documentation is essential for IRS purposes if you sell later.

• Federal and State Tax Implications: North Carolina has no estate or inheritance tax, but federal estate taxes apply if the estate exceeds the exemption (currently over $13 million per person). Capital gains on sales are taxed federally (at long-term rates if held over a year) and at the state level as ordinary income.

• Planning Ahead: Avoid adding heirs to deeds during your lifetime—it can trigger gift taxes and prevent a step-up. Instead, use wills, trusts, or joint ownership strategically.

• Seek Professional Advice: This isn't tax or legal advice. Estate planning is highly personal, and mistakes can be costly. Consult a North Carolina estate attorney or CPA to tailor a plan to your situation.

Inheriting real estate can be a blessing, but understanding step-up in basis helps maximize its value. Proper planning ensures your heirs benefit fully while minimizing tax burdens. If you're navigating this process, reach out to experts early—it's worth the investment.