Basis, debt and the arithmetic of an estate

Debt reduces what passes. Basis governs what a later sale recognises. They are independent quantities, and conflating them produces an error exactly the size of the loan.

The estate arithmetic is the easy half. Collateral of $4,180,000 against a loan of $1,455,000 leaves $2,725,000 of net value. The debt is subtracted because it is owed, and nothing about that subtraction touches the shares themselves.

The basis arithmetic is the half that surprises. Where a system adjusts basis to value at death, the adjustment is generally keyed to the gross value of the asset rather than to the net of what was borrowed against it. So the basis becomes $4,180,000, not $2,725,000. The borrowing reduced what passed and did not reduce the figure subtracted on a later sale.

Follow it to the sale. The inheritor sells the whole holding at $4,180,000, repays $1,455,000, keeps $2,725,000, and recognises nothing. Under a rule keyed to the net figure instead, the basis would be $2,725,000 and the same sale would recognise $4,180,000 − $2,725,000 = $1,455,000 — the loan, exactly. Systems differ on this, and the difference is not small.

Two further mechanical facts belong here. Pledging an asset does not change its basis, because a pledge is not a transaction in the asset. And repaying a loan does not create basis in anything, because a repayment returns borrowed money rather than acquiring property. Which convention applies, and what exceptions sit around it, is a question for an adviser with the actual documents in front of them.