When thinking about estate planning, many people focus on wills, trusts, and guardianship designations. While these are important, there’s another critical element that often flies under the radar but can offer significant tax savings for your loved ones: the step-up in basis.
This powerful provision in the U.S. tax code can minimize—or even eliminate—capital gains taxes on inherited assets. Whether you’re passing down real estate, stocks, or other investments, understanding the step-up in basis can make a huge difference in preserving your legacy and protecting your family’s financial future.
What Is Basis?
To understand the concept of a “step-up in basis,” you first need to understand what “basis” means. The basis of an asset is typically what you paid for it originally. For example, if you bought a house for $300,000, your basis is $300,000. If the house appreciates in value and is worth $500,000 when you sell it, you may owe capital gains tax on the $200,000 profit.
However, when you pass assets to heirs, the IRS allows the cost basis of those assets to be “stepped up” to their fair market value at the date of death. That’s where the tax magic happens.
What Is a Step-Up in Basis?
A step-up in basis adjusts the value of an inherited asset to its current fair market value at the time of the decedent’s death. This means your heirs won’t owe capital gains taxes on any appreciation that occurred during your lifetime. They only owe taxes (if at all) on appreciation that occurs after they inherit the asset.
Here’s a simple example:
- You buy Apple stock for $10,000 in 1995.
- It’s worth $250,000 when you pass away in 2025.
- Your heir receives the stock with a stepped-up basis of $250,000.
- If they sell it for $255,000 in the future, they only pay tax on the $5,000 gain—not the $240,000 appreciation that occurred during your lifetime.
This provision can save heirs tens or hundreds of thousands of dollars in taxes depending on the size and type of assets inherited.
Why the Step-Up in Basis Matters in Estate Planning
The step-up in basis is one of the most effective tools to preserve family wealth across generations. If you don’t plan properly, your beneficiaries may inadvertently lose this benefit and face large capital gains tax bills.
Here are key reasons why you shouldn’t ignore this benefit:
1. Tax Efficiency for Heirs
The primary advantage of the step-up in basis is tax savings. If your heirs sell an appreciated asset, the new basis significantly reduces their taxable gain—or eliminates it entirely. This makes it easier for them to retain more of their inheritance.
2. Incentive to Hold Appreciated Assets
Because heirs can receive a tax-free reset on the value of an asset, it may make sense to hold onto highly appreciated assets until death, rather than selling during life and incurring capital gains tax.
3. Estate Planning Strategy
The step-up in basis can be integrated into a broader estate plan. For example, certain trusts (like revocable living trusts) allow assets to retain their eligibility for a step-up. However, some irrevocable trusts may lose this benefit unless carefully structured. This is where professional estate planning guidance is crucial.
What Assets Qualify for Step-Up in Basis?
Most capital assets are eligible for a step-up in basis, including:
- Real estate (your primary residence or rental properties)
- Stocks, bonds, and mutual funds
- Business interests
- Collectibles and art
However, not all assets qualify. For example, retirement accounts like IRAs or 401(k)s do not receive a step-up in basis. These are considered “income in respect of a decedent” (IRD), and beneficiaries must pay income tax when withdrawing funds.
Community Property Advantage in California
As a San Diego-based law firm, we work with many clients who are married and own community property. California is a community property state, which offers an even bigger advantage when it comes to step-up in basis.
In community property states like California:
- If a couple owns an asset as community property, both spouses’ halves of the asset get a step-up in basis upon the death of one spouse.
- This means the surviving spouse gets a full step-up, not just on the deceased spouse’s share.
For example, if a couple jointly owns a rental property worth $1 million (purchased for $200,000), and one spouse dies, the surviving spouse’s basis becomes $1 million—not $600,000. This offers a clean slate for future tax planning or asset sales.
Potential Legislative Changes
The step-up in basis has been in the spotlight for years, with various tax reform proposals aiming to limit or eliminate it. While it has survived recent reform efforts, it’s important to stay informed, as changes to this rule could dramatically affect your estate plan.
Working with a professional estate planner ensures that your plan is adaptable in case laws change. Proactive strategies can be developed to maintain tax efficiency even in a shifting legislative environment.
Mistakes to Avoid
Even though the step-up in basis is a powerful benefit, it can be lost through poor planning. Here are some common pitfalls:
- Gifting appreciated assets before death: If you gift an appreciated asset during your lifetime, your recipient receives your original basis—not a stepped-up one.
- Incorrect trust structures: Some irrevocable trusts may disqualify assets from receiving a step-up in basis.
- Poor recordkeeping: If the basis of an asset isn’t clearly documented, it may create complications or disputes later.
Proper estate planning helps avoid these missteps and ensures your family receives the full benefit of your lifetime’s hard work and investments.
When to Start Planning
The best time to start estate planning is now. Whether your estate is modest or complex, the sooner you begin, the more options you have to structure your legacy intelligently. A thoughtful plan ensures your loved ones inherit not just your assets—but the protection and tax efficiency that goes with them.
Working with an estate planning attorney in San Diego who understands local property laws and federal tax code is the key to creating a smart, flexible plan that leverages every benefit available to you—including the step-up in basis.
How we can help
At Allenby Law, we specialize in simplifying estate planning for individuals and families throughout San Diego. Our approach is smart, forward-thinking, and tailored to your unique goals. We’ll help you preserve your legacy, protect your loved ones, and make full use of powerful tools like the step-up in basis.
Whether you’re just getting started or reviewing your existing estate plan, we’ll guide you through every step. Don’t leave valuable tax benefits on the table—reach out to us today to create a plan that works for you and the people you care about.
Let Allenby Law help you turn complexity into clarity.
