With the death of a loved one, one question we often get is, “What assets are entitled to a step-up in basis and what assets aren’t entitled to a step-up in basis at death?” To define what we mean by step-up in basis, sometimes referred to as stepped-up basis, here is an example:
Your mother purchased 100 shares of XYZ company at $10 per share in 1950, costing her $1,000, which is her “basis.” She holds the shares without selling until she passes away in 2022. The share price is $1,000 per share at her date of death.
Despite the fact that she has a significant gain of $99,000 in this example, the basis “steps up” on the date of death to the share price on that date – or $100,000. If the beneficiary of this stock decides to sell it a few months later, their basis is $100,000 and the gain or loss is simply the value of the shares sold minus the basis. For example, if they were sold at a value of $110,000, they would owe tax on $10,000 of capital gains. Assets acquired by inheritance is always considered to be long-term gains.
Understanding the Importance of Step-Up In Basis
A step-up in basis can be a significant tax-saving tool for beneficiaries. By resetting the asset’s value to the fair market value at the decedent’s date of death, the step-up can drastically reduce capital gains taxes if sold shortly after the assets are inherited (as they haven’t had a lot of time to appreciate and cause a capital gain). This tax relief can provide heirs with more flexibility and financial security since they may not have a substantial tax burden to plan around.
How Step-Up in Basis Impacts Estate Planning
It is common to overlook tax implications when estate planning, focusing more on who receives what rather than seeking to minimize future taxes for heirs. Strategically planning for assets with a potential step-up in basis can help facilitate tax-efficient wealth transfers. While the heart may be in the right place, there are cases where gifting the “wrong” assets to heirs prior to death may have a catastrophic impact on taxation. It is important to work with professionals such as wealth managers and estate planning attorneys that understand how to maximize step-up benefits.
Examples of Assets That Step-Up in Basis
- Individual stocks, bonds, mutual funds, and exchange-traded funds (ETFs) held in taxable accounts.
- Real estate – this includes many forms, such as multi-family residences, primary residences, vacation homes, and office buildings.
- Businesses and the equipment in the business.
- Art, collectibles, home furnishings – such as antiques that may have increased in value.
- Cryptocurrencies.
- Non-fungible tokens, or NFTs.
Examples of Assets That Do NOT Step-Up in Basis
- Individual retirement accounts, including IRAs and Roth IRAs.
- 401(k), 403(b), 457 employer-sponsored retirement plans and pensions.
- Real estate that was gifted prior to inheritance.
- Tax-deferred annuities.
How The Step-Up in Basis Rule Works for Married Couples
Assets owned jointly by a married couple in community property states often receive a full step-up in basis at the first spouse’s death. This step-up benefit can be a considerable advantage to the surviving spouse, as it can eliminate capital gains tax if the surviving spouse chooses to sell the assets. In common law states the assets are considered to be jointly held, and as a result the surviving spouse may only be able to take a step-up in basis for only the decedent’s share of assets.
For a list of community property states and what assets are considered to be community property, check out this blog from trust&will.
State Level Considerations for Step-Up in Basis
Some states have different rules for how step-up in basis is applied or do not follow the federal guidelines. Knowing your state’s regulations is essential, as state estate and inheritance taxes can impact heirs, especially the states with separate inheritance tax rules.
Step-Up in Basis Exceptions and Special Circumstances
Certain circumstances may alter or limit the step-up in basis. These include:
- Trusts – assets in some trusts like irrevocable ones may not be eligible for a step-up in basis. Revocable trust assets generally do receive step-up treatment.
- Gifting prior to death – the recipient of the gift typically will receive your original basis, also known as a “carryover basis” and will not receive the step-up in basis.
Potential Legislative Changes to Step-Up in Basis
In recent years and with the personal tax cuts set to expire at the end of 2025, there is plenty of speculation on how step-up in basis will be treated in the future. Stay informed of these legislative updates, and understand that your estate plan may need to be updated in the future.
Conclusion: A Step-Up in Basis Can Be a Financial Opportunity for Beneficiaries
Understanding the step-up in basis is essential for beneficiaries and those planning their estates. By strategically approaching how assets are held, gifted, or inherited, families can reduce tax burdens and improve wealth transfer outcomes.
We encourage our clients to consult with a qualified estate planning attorney and wealth manager to ensure their wishes are thoughtfully planned and to make informed decisions that minimize future tax burdens while avoiding unintended consequences.
Note: Please consult a tax professional and/or an estate planning attorney if you have any tax and estate questions specific to your own personal situation.
