What Is a Step-Up in Basis in Estate Planning? Key Tax Benefits Explained

If you’re managing a loved one’s estate or planning your own legacy, understanding the “step-up in basis” rule is essential for effective estate planning and minimizing capital gains taxes. This powerful tax provision can help preserve wealth and reduce tax burdens for your heirs—but it must be carefully incorporated into your estate plan to maximize its benefits.

This article explains how the step-up in basis works, when it applies, and why it plays a crucial role in tax-efficient estate planning.

🧾 What Is Tax Basis and How Are Capital Gains Calculated?

Before we dive into the step-up in basis, let’s quickly cover two key concepts: tax basis and capital gains.

👉 Tax Basis Defined:

Your tax basis (or cost basis) is generally the amount you paid for an asset, including purchase price, commissions, and certain improvements. It represents your starting point for determining profit or loss when you sell that asset.

Example: If you buy stock for $50 per share, your basis is $50 per share.

👉 Capital Gains Tax:

When you sell an asset for more than your basis, the difference is called a capital gain, and it’s subject to capital gains tax.

Example: If you sell that stock for $150 per share, you have a $100 capital gain per share.

The capital gains tax rate depends on how long you held the asset and your income level. In most cases, long-term capital gains are taxed at a lower rate than ordinary income.

📈 What Is a Step-Up in Basis?

A step-up in basis is a tax rule that adjusts the basis of inherited property to its fair market value (FMV) at the time of the original owner’s death. This adjustment can significantly reduce or eliminate capital gains taxes when the property is later sold by a beneficiary.

Example of a Step-Up in Basis:

Let’s say your mother purchased a rental property for $100,000. At the time of her death, the property is worth $400,000. If you inherit it, your new tax basis is $400,000. If you later sell it for $420,000, you only pay capital gains tax on the $20,000 gain—not the $320,000 gain from her original purchase.

🛡️ Why the Step-Up in Basis Matters in Estate Planning

Using the step-up in basis strategically in your estate plan can:

✅ Minimize capital gains taxes for your heirs
✅ Avoid negative tax consequences of lifetime gifting
✅ Support fair and simplified estate asset division
✅ Enable heirs to sell inherited assets with less tax liability

⚠️ **When the Step-Up in Basis Does Not Apply**

It’s important to understand that the step-up in basis doesn’t apply to every asset or every situation.

Assets That Do Not Receive a Step-Up in Basis:

Retirement accounts (IRAs, 401(k)s) – taxed as income, not capital gains
Assets gifted during your lifetime – carry your original basis, not a stepped-up one
Assets outside the taxable estate – may lose eligibility for a basis adjustment

🏛️ Step-Up in Basis and the Taxable Estate: A Crucial Consideration

A lesser-known but critical point: only assets included in your taxable estate are eligible for a step-up in basis.

This has major implications. In efforts to avoid estate taxes, some people move assets into irrevocable trusts or gift them during life. But this can exclude those assets from the taxable estate—and from receiving a basis step-up.

With today’s high federal estate tax exemption ($13.99 million per individual as of 2025), many families aren’t subject to estate tax. So, losing the step-up to avoid a tax that doesn’t even apply could actually cost your heirs more in capital gains taxes.

Trusts and Step-Up Risks:

For example, an intentionally defective grantor trust (IDGT) may be structured to exclude assets from the estate. But those assets might miss out on the step-up, leading to significant tax exposure for your beneficiaries.

This is why a balanced estate plan considers both estate tax and income tax consequences.

Side Note: Some advisors promote structures they claim allow assets to avoid estate tax and receive a step-up in basis. The IRS disagrees, see Revenue Ruling 2023-2. This Revenue Ruling does not apply to all irrevocable trusts, only to irrevocable trusts that sidestep the estate tax.

📍 Ownership Structure and State Law Considerations

Your state and how your property is titled can affect step-up eligibility:

Community property states (e.g., California, Texas): Both spouses’ halves of property may get a full step-up at the first death.
Common law states: Only the deceased spouse’s portion typically receives the step-up.

✅ Key Takeaways

Tax basis determines capital gains; the step-up resets that basis at death.
The step-up in basis can significantly reduce or eliminate capital gains tax on inherited property.
Assets must be included in the taxable estate to qualify for a step-up in basis.
Certain trusts and gifting strategies can inadvertently remove step-up eligibility.
A comprehensive estate plan should evaluate both estate tax and income tax impacts.

👨‍⚖️ Work with an Experienced Estate Planning Attorney

At Paramus Estate Planning our estate planning attorneys in Bergen County, New Jersey help clients make informed, strategic decisions about tax-efficient wealth transfer. Whether you’re looking to update your estate plan or navigate complex tax rules, we can guide you.