Most people first hear the term “step-up in basis” while setting up a loved one’s estate. That’s one of the worst times to learn about it because by then, the time to make the decisions that could have made a real difference has already passed. 

For people who have spent decades building wealth, knowing what asset and inherited property cost basis means for their estate and tax planning is vital. Unfortunately, it’s rarely discussed.  

Let’s start by looking at how a step-up in basis works. 

Key takeaways: 

• A step-up in basis resets the cost basis of an inherited asset to its market value at the date of the owner’s death, which can significantly reduce or eliminate capital gains tax.
• The adjustment applies to stocks, bonds, real estate, and other capital assets held in taxable accounts, but not to traditional IRAs and 401(k)s.
• Gifting appreciated assets during your lifetime transfers your original cost basis and tax liability to the recipient, whereas passing them down at death triggers the tax-saving step-up.
• Assets in irrevocable grantor trusts qualify for a step-up only if they are included in the taxable estate at death, and real estate often sees the most dramatic impact because of long-term appreciation. 

What is a Step-Up in Basis 

When you inherit an asset, whether that be stocks, real estate, or other investments, the IRS doesn’t make you pay capital gains tax (tax on profits from selling an investment or capital asset) based on what the original owner paid for it. 

Instead, it resets the cost basis to the market value at the date of that person’s death. 

Why Does That Matter? 

Because capital gains tax is calculated on the difference between what you paid for something and what you sell it for, thus a higher starting basis means a smaller taxable gain, or sometimes no taxable gain at all. 

That reset is the step-up in basis for inherited assets, which can save far more than most realize for heirs inheriting significantly appreciated assets. 

Note that it’s not always an upward adjustment. The term “step-up” can be misleading because an asset’s adjusted basis could be lower than the original price if it has declined in value. 

What a Step-Up in Basis Looks Like in Practice 

Say a person invested in stock for $10,000 in 1990, and by the time they pass away, that stock is worth $200,000. 

Without a step-up in basis, the heir inherits a $190,000 capital gains tax problem along with the investment. But with the step-up, the inherited property cost basis resets to $200,000. I.e., the value at the date of death. 

If the heir sells the stock immediately, they will owe nothing in capital gains tax. That’s a huge difference, hence why understanding what a step-up in basis is and why it matters for heirs is more than a technical detail in your estate planning. 

Which Assets Can Receive a Step-Up? 

A step-up in basis for inherited assets can apply to various types of property, including: 

• Stocks 
• Bonds 
• Interests in privately held businesses 
• Other capital assets held in taxable brokerage or investment accounts 

On the other hand, traditional IRAs and employer-sponsored retirement accounts like 401(k)s don’t qualify. Withdrawals from these accounts are taxed as ordinary income regardless of when or how the account was inherited. 

Ownership and Transfer Matter 

A jointly owned asset doesn’t necessarily receive the same basis adjustment for every owner’s share. In some cases, only the deceased owner’s portion receives an adjustment, while special rules can apply to community property. 

Gifted assets are another exception. When you give an appreciated asset to someone during your lifetime, they inherit your original cost basis. This brings up another key point in understanding how a step-up in basis works… 

The Difference Between Inheriting and Receiving a Gift 

Another distinction that matters for estate planning is that gifting and inheriting an asset can produce very different tax results. 

This is because passing down investments to your children while you’re alive means the recipient takes on your original cost basis. So, if you bought stock for $10,000 and it’s now worth $150,000, gifting it means passing along a $130,000 capital gains tax liability. 

If you pass that same asset at death, the step-up in basis for inherited assets resets the cost basis to $150,000. The $130,000 gain disappears for tax purposes. 

What About Assets in an Irrevocable Trust? 

If you hold or are considering an irrevocable trust as part of your estate plan, a 2023 IRS ruling (Revenue Ruling 2023-2) is important to keep in mind.

The IRS clarified that assets in an irrevocable grantor trust do not automatically receive a step-up in basis upon the grantor’s death if those assets are excluded from their taxable estate.

This means that even if you pay income tax on the trust during your lifetime, the assets must be part of your taxable estate at death to qualify for the basis adjustment. 

Real Estate and the Step-Up in Basis 

For most families, the home is the single largest asset they’ll ever pass on; thus the question of why a step-up in basis matters for heirs inheriting property cannot be ignored. 

Real estate is where the step-up in inherited property cost basis tends to have the most dramatic impact because real estate bought decades ago has usually appreciated far beyond its original purchase price. 

For example, a family home bought for $150,000 in 1985 may be worth $900,000 today. Without a step-up in basis, the heirs would face capital gains tax on $750,000 when they sell.

Other Real Estate Considerations 

The actual tax calculation on inherited property also involves factors such as depreciation, improvements, ownership structure, and how the property is transferred. A step-up is valuable, yes, but it’s only one part of planning for inherited property. 

A Step-Up Isn’t a Substitute for Estate Planning 

It’s one thing to know what a step-up in basis is, but another to actually benefit from it. 

Many other factors matter when you want to leave your heirs the full benefit of your estate, including beneficiary designations, asset ownership, investment strategy, tax planning, liquidity needs, and your family’s goals. 

The team at WealthArch Investment Services works with clients through exactly this kind of planning. Ready to take a closer look at your estate strategy? Schedule a consultation with us today.