The Step-Up In Basis Rule: What to Know When Estate Planning

Maggie had dealt with all the arrangements of her father’s passing. She planned the wake, cancelled his credit cards, and notified all his banks and insurance companies. Now, after speaking with the probate attorney, she learned that her father had bought stock 40 years ago that had now been left to her. She was unsure what to do with it. If she sold it, she was concerned about capital gains tax—the tax on the gained value when an asset is sold for more than the purchase price.

However, when she went over it with her financial professional, she learned that the purchase price was stepped up to the current market value at the date of her father’s death, rather than the price her father originally paid. This is the “step-up in basis” rule and can be a helpful tool in estate and legacy planning.

“The step-up in basis can potentially reduce taxes for a family, depending on how assets are structured and transferred,” explains Joseph Aspelund, Branch manager at David Lerner Associates. “Understanding how your assets are titled and how they pass at death can help provide greater structure in legacy planning.”

What is the Step-Up In Basis Rule

The step-up in basis rule is a tax concept that applies when someone inherits an asset, like a house, stocks, or other investments from a decadent—the original owner that has passed. It establishes that the asset’s tax basis “resets” to its fair market value at the time of the decadent’s death. This means that when you inherit something, the IRS treats it like you acquired it at its current value, not what the original owner paid for it.

As a result, any growth in value during the lifetime of the original asset owner is generally not subject to federal capital gains tax upon inheritance. For families holding appreciated real estate, stocks, or business interests, this can represent a significant tax benefit.

How the Rule Works in Practice

Suppose your parent purchased a rental property for $100,000 that is now worth $800,000. If they had sold the property during their lifetime, they would have owed capital gains tax on up to $700,000 of gain (subject to depreciation recapture and applicable exclusions). If instead they held the property until death and you inherit it, your basis becomes $800,000. If you sell shortly afterward for $800,000, your taxable gain would generally be zero.

What Qualifies and What Does Not

The step-up in basis applies to assets held in taxable accounts that are included in the decedent’s gross estate. This typically includes individual brokerage accounts, real property, and interests in closely held businesses. It’s important to note that assets passing to an heir from an irrevocable trust are not always eligible for a step-up in cost basis.

Assets that Can Receive a Step-Up In Basis:

• Real estate
• Individual stocks or bonds
• Mutual funds
• Art, furnishings, and collectibles
• Some business interests

Assets that Can Not Receive a Step-Up in Basis:

• Bank accounts and cash
• Certificates of deposit
• 401(k)s and other employer-sponsored retirement plans
• IRAs, pensions, and annuities

When you inherit one of these assets, you retain the original owner’s cost basis.

Gifting vs. Inheriting

A step-up in basis does not apply to gifts made during the owner’s lifetime; instead, the recipient generally keeps the original cost basis.

This distinction matters significantly for planning. Gifting a highly appreciated asset before death can pass along a built-in tax burden to the recipient, whereas holding it until death can eliminate that liability if set up effectively. In some cases, it may make more sense to leave an appreciated asset to heirs and gift other assets instead. Factoring in the reality of how these assets will be transferred can help make the most out of your estate planning.

The Step-Up In Basis for Spouses

For married couples, the rules around basis can differ depending on how assets are titled. In community property states, when one spouse dies, the entire asset gets a fresh tax value, including the surviving spouse’s share. In common law states, only the deceased spouse’s share of a jointly held asset receives the step-up. The difference can be substantial and is worth understanding based on your state of residence.

Planning For Future Considerations

When considering long-term implications, it is important to remember that policies can be adjusted or changed in the future. Explore ways that your estate plan can account for the possibility of future changes, while maximizing the benefit under current law.

Understanding how the step-up in basis rule impacts your estate planning can help you prepare for your situation, manage appreciated assets, and gift thoughtfully. Planning now, while you are still able to, can help ensure your wishes—and legacy—are enacted the way you intend.

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 Material contained in this article is provided for information purposes only. It is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. These materials are provided for general information and educational purposes, based on publicly available information from sources believed to be reliable. We cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. The subjects of this article are fictitious and created for illustrative purposes only. They are based on events of a similar nature and should not be interpreted as direct depictions of any specific individuals, organizations, or incidents. Any resemblance to actual persons, living or deceased, or actual events is purely coincidental.