Step-Up in Basis

Step-up in basis is a tax provision that adjusts the cost basis of inherited assets to their fair market value (FMV) at the date of the decedent's death, effectively eliminating capital gains taxes on appreciation during the original owner's lifetime.

How It Works:

Before Step-Up (During Life):

• Original purchase: $10,000
• Value at death: $100,000
• Unrealized gain: $90,000
• If sold by original owner: $90,000 taxable gain

After Step-Up (Inherited):

• New cost basis: $100,000 (FMV at death)
• Immediate sale: $0 taxable gain
• All $90,000 gain eliminated!

Example:

Scenario	Without Step-Up	With Step-Up
Original basis	$50,000	$50,000
Value at death	$500,000	$500,000
New basis	$50,000	$500,000
Tax on immediate sale	$67,500 (15% × $450k)	$0

Assets Eligible for Step-Up:

• Stocks and bonds
• Mutual funds and ETFs
• Real estate
• Business interests
• Collectibles
• Most other capital assets

Assets NOT Eligible:

• Retirement accounts (IRA, 401k) - already tax-deferred
• Annuities
• Items that generate "income in respect of decedent"

Planning Strategies:

1. Hold Appreciated Assets Until Death:

• Don't sell highly appreciated assets
• Let heirs receive step-up
• Particularly valuable for long-held real estate

2. Gift Low-Basis Assets During Life (Sometimes):

• Gifts carry over donor's basis (no step-up)
• But may make sense for appreciated assets given to those in lower tax brackets

3. Don't Gift High-Basis Assets:

• No benefit from step-up if given away
• Better to sell and gift cash

4. Beware of Step-Down:

• Assets worth LESS than basis step DOWN
• Consider selling losers before death to harvest losses

Alternate Valuation Date:

• Estate can choose date 6 months after death
• If estate value decreased, may lower estate tax
• Affects beneficiaries' basis

Community Property States:

• Both halves of community property get step-up
• Even the surviving spouse's half
• States: AZ, CA, ID, LA, NV, NM, TX, WA, WI

Important Notes:

• Step-up only at death, not between living persons
• Joint accounts: only decedent's portion steps up
• Proper documentation of FMV is essential