Step-Up In Basis Archives - Good Life Wealth Management

A plain-English guide to inherited assets, joint accounts, real estate, IRAs, Roth IRAs, and when taxes should influence investment decisions.

One of the questions I hear often is whether it makes sense to hold on to an appreciated investment simply to preserve a future step-up in basis. It is a smart question, because the step-up in cost basis is one of the most valuable tax benefits available under U.S. tax law. But the answer is more nuanced than many people realize.

A step-up in cost basis means that when someone dies, certain assets may receive a new tax basis equal to their fair market value on the date of death. Suppose you bought an investment years ago for $100,000 and it is worth $600,000 when you pass away. If you sold it during your lifetime, you would generally owe capital gains tax on the $500,000 gain. But if the investment is held in a taxable account until death and your heirs inherit it, their new basis may be $600,000. If they sold it soon after, there may be little or no capital gains tax on that prior appreciation.

That is an extraordinary benefit. It can eliminate decades of unrealized gains. It can simplify estate settlement. And in some cases, it can save a family tens or even hundreds of thousands of dollars. But it is also easy to overgeneralize. Not every account receives a step-up. Joint ownership can change the result. Community property rules matter only in specific situations. And sometimes the desire to preserve a future step-up causes investors to make poor portfolio decisions today.

Here are the key concepts I think retirees and pre-retirees should understand.

The Step-Up Applies to Taxable Accounts, Not Every Account

The first thing to understand is that the account type matters more than the investment itself. Investors often ask whether a stock, ETF, mutual fund, or bond receives a step-up. That is not really the right question. The better question is: what type of account owns the investment?

Appreciated investments held in a taxable brokerage account generally receive a step-up in basis at death. The same investment held inside a traditional IRA, 401(k), 403(b), pension plan, Roth IRA, or non-qualified annuity follows a different set of rules and generally does not receive a step-up in basis.

That distinction matters. The exact same S&P 500 ETF might receive a step-up if it is held in a taxable brokerage account, but not if it is held inside an IRA. In the IRA, the beneficiary inherits the retirement account rules, not the taxable brokerage account rules.

Traditional IRAs and employer retirement plans usually remain taxable to beneficiaries as distributions are taken. In other words, the beneficiary does not inherit a new basis that wipes out the embedded income tax liability. Non-qualified annuities also generally do not receive a step-up in basis. The owner’s investment in the contract carries over, while deferred earnings are generally taxable as ordinary income when withdrawn. A common mistake: leaving money to charity from a taxable account. No, leave the charity money from your IRA. They will not owe taxes on it, but your children or heirs would. And the money in the taxable account is better given to heirs who get a step-up.

Roth IRAs deserve special mention because they are different. A Roth IRA does not receive a step-up in basis, but in most cases it does not need one. Qualified Roth IRA withdrawals are already income tax-free. Under current law, many non-spouse beneficiaries have up to 10 years to fully distribute an inherited Roth IRA, which means they may be able to allow the account to continue growing tax-free for much or all of that period before taking tax-free withdrawals. For heirs, that might make a Roth IRA the most tax-efficient asset to inherit.

For more detail on inherited IRAs, the 10-year rule, spousal options, Roth IRAs, and required minimum distributions, see my article: Stretch IRA & Inherited IRA Rules (2026): RMDs, Grandfathering, Spousal & Roth Rules.

Real Estate Can Also Receive a Step-Up

The step-up in basis is not limited to brokerage accounts. Real estate is often where this rule becomes especially powerful. Think about a house a grandmother bought 50 years ago for $40,000 that is now worth $700,000. If she sells the home during life, there may be capital gains tax depending on her basis, improvements, and whether the home qualifies for the primary residence exclusion. If her heirs inherit the property at death, the tax basis may be adjusted to the date-of-death value, potentially eliminating decades of unrealized appreciation.

There is also a separate tax rule for primary residences. The primary residence capital gains exclusion allows a homeowner to exclude up to $250,000 of gain from income, or up to $500,000 for many married couples filing jointly, if the house was their primary residence for two of the prior five years. This is not the same thing as the step-up in basis. It is a separate lifetime exclusion that may apply when someone sells a qualifying primary residence while they are living.

Because these rules can interact in important ways, be careful before selling a home, moving out of a long-time residence, gifting part of the home, adding children to the title, or changing ownership. A well-intentioned title change can create tax consequences that are not obvious at the time.

I have a separate article on keeping track of home improvements and home basis here: Tracking Your Home Improvements.

Your State Matters for Joint Accounts

State law is especially important when married couples own appreciated assets jointly. If an asset is individually owned, the community property versus common law distinction is generally not the main issue. But for joint accounts, it can make a significant difference.

Most states are common law states. In a common law state, jointly owned property between spouses generally receives a step-up on only the deceased spouse’s half of the account. The surviving spouse’s half typically retains its original basis.

Community property states are different. The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska also allows couples to elect community property treatment in certain circumstances. In community property states, qualifying community property generally receives a full step-up in basis when the first spouse dies. That means both halves of the community property may receive a new basis, not just the deceased spouse’s half.

This is a major advantage for married couples in community property states, but the account title and legal character of the property still matter. A generic joint account title may not necessarily preserve community-property treatment in the way the couple expects. The optimal registration may be Community Property with Right of Survivorship when available and appropriate, because it can combine probate avoidance with the potential for a full step-up in basis.

In common law states, Joint Tenants with Right of Survivorship is commonly used because the account passes automatically to the surviving spouse and avoids probate. But from a basis standpoint, it generally results in only a partial step-up. Tenants in common may have different estate planning consequences because the deceased owner’s share may pass under a will or trust rather than automatically to the surviving owner. A Transfer on Death designation can also avoid probate while preserving individual ownership during life.

Be Careful With End-of-Life Retitling

When one spouse is terminally ill, it may be appropriate to review how appreciated taxable assets are owned. In a common law state, if the terminally ill spouse owns an appreciated taxable account individually and the surviving spouse is named as the Transfer on Death beneficiary, the entire account may receive a step-up in basis at death. By contrast, a jointly owned account may receive only a partial step-up.

That planning opportunity is real, but it is not as simple as transferring everything to the less healthy spouse at the last minute. There is an important one-year anti-abuse rule under Section 1014(e). In simplified terms, if appreciated property is gifted to a person within one year of death and then passes back to the original donor, or the donor’s spouse, the step-up may be denied for that property. This rule is designed to prevent someone from transferring appreciated assets to a dying person solely to reacquire them with a new basis.

That does not mean ownership planning is off the table. It means it must be done carefully, with the estate planning attorney and tax advisor involved. The right approach depends on who currently owns the asset, whether the transfer is a gift, how long the asset is held, who will inherit it, whether a trust is involved, creditor issues, Medicaid considerations, and state property law.

The lesson is not that retirees should avoid end-of-life basis planning. The lesson is that these decisions are too important to handle casually. A few minutes spent reviewing titling can create a major tax benefit, but a poorly executed title change can also create the opposite result.

Do Not Add Children as Joint Owners Just to Avoid Probate

One of the worst ideas is adding an adult child as a joint owner on a brokerage account or home to make things easier after death. It sounds simple. The child can help pay bills. The account avoids probate. Everyone assumes it is harmless.

But adding a child as a joint owner can create tax and legal problems. If the child becomes a current owner, part of the asset may no longer receive the full step-up at the parent’s death. There may also be gift tax reporting issues, creditor exposure, divorce exposure, family conflict, and loss of control. In many cases, a Transfer on Death designation, beneficiary designation, revocable living trust, or properly drafted estate plan can accomplish the same probate-avoidance goal without giving up the tax benefits of retaining ownership until death.

This is one of those areas where the simplest-looking solution is not always the best one. Probate avoidance is important, but it should not be pursued in a way that accidentally creates a larger capital gains problem for the family.

The Tax Cost of Selling an Appreciated Investment

Of course, the step-up in basis is only relevant if you hold the asset until death. Sometimes selling during life is the better decision. Before realizing a large gain, we evaluate the complete tax picture, not just the federal capital gains rate.

Long-term capital gains are generally taxed federally at 0%, 15%, or 20%, depending on taxable income. Higher-income taxpayers may also owe the 3.8% Net Investment Income Tax. For individuals, this surtax generally becomes relevant when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly. For Medicare beneficiaries, a large capital gain can also increase modified adjusted gross income enough to trigger higher Medicare Part B and Part D premiums through IRMAA. Because IRMAA is based on income from two years prior, a large gain this year can affect Medicare premiums in a future year. State income taxes may also apply.

That means the true tax cost of selling can be much more than a simple 15% capital gains rate. For one retiree, harvesting a gain might be very manageable. For another, the same sale might push them into NIIT, higher Medicare premiums, and a higher state tax bill. That is why these decisions should be modeled individually.

This is also why tax planning is such an important part of retirement planning. You can learn more in our Tax Planning for Retirees hub.

Do Not Let the Tax Tail Wag the Investment Dog

While taxes matter, they should not be the only consideration. Some investors hold on to concentrated stock positions, high-cost mutual funds, or weak investments because they do not want to pay capital gains tax. They are waiting for the step-up in basis to solve the problem someday.

That can be a reasonable strategy for someone with a short life expectancy and a well-diversified portfolio. But for a healthy 65-year-old, it may be a mistake. One or both spouses may live another 20 or 30 years. Over that time, a poorly diversified portfolio, excessive fees, or an underperforming investment can cost far more than the capital gains tax that was being deferred.

Avoiding a 15% capital gains tax today may feel good, but it should not be the sole reason to hold an investment for decades. The objective is not to minimize taxes at all costs. The objective is to maximize after-tax wealth over your lifetime while maintaining a portfolio that fits your goals, risk tolerance, income needs, and estate plan.

Investment decisions, withdrawal strategies, Social Security timing, Roth conversions, tax brackets, Medicare premiums, and estate planning all fit together. That is the heart of retirement income planning. You can explore those topics further in our Retirement Income Planning hub.

Putting It All Together

The step-up in cost basis is a powerful planning tool, but it is not a magic rule that applies equally to every account and every situation. Taxable brokerage accounts and real estate may receive a basis adjustment at death. Retirement accounts and annuities generally follow different rules. Joint accounts may receive a partial or full step-up depending on state law and titling. End-of-life ownership changes can create opportunities, but they can also trigger traps if handled incorrectly.

For retirees and pre-retirees, the key is balance. It is wise to understand and preserve valuable tax benefits. It is also wise not to let a future tax benefit prevent you from making good investment decisions today. A strong financial plan should coordinate tax planning, portfolio management, retirement income, estate planning, and family goals.

As always, before making major changes to account ownership, selling highly appreciated investments, transferring real estate, or changing beneficiary designations, consult with your financial advisor, estate planning attorney, and tax professional. The rules are too important—and too fact-specific—to rely on general assumptions.

Today, we look at strategies if the step-up is basis in eliminated for estate planning. There were two new proposals in the Senate this week which will target inherited wealth. These two Acts, if passed, would completely change Estate Planning for many families. The two Acts are called the STEP Act and the 99.5% Act.

The STEP Act

The STEP Act (Sensible Taxation and Equity Promotion Act), proposed by Senators Booker, Sanders, Warren, Whitehouse, and Van Hook would eliminate the Step-Up in Cost Basis. A Step-Up in Basis means that upon Death, an asset has its cost basis reset to the date of death. This allows the heirs to immediately sell an asset and receive the funds without owing any taxes. Or, if they choose to hold on to the asset, they will only owe tax on the capital gains from the date of death forward. Otherwise, they would owe taxes based on their parent’s cost basis (or other decedent).

The STEP Act proposes to eliminate the Step Up in Basis, retroactively to January 1, 2021. In its place, the Act would allow a one-time exclusion of up to $1 million of inherited capital gains. It also allows the tax to be paid over 15 years if it is an illiquid asset like a farm or business. Many older parents have held on to assets, such as mutual funds or real estate, specifically to get a step-up in basis for their children. Allowing for the exclusion of $1 million in capital gains at death will help most families. But include real estate, and many families will have over $1 million in unrealized capital gains. And those families will now be paying a capital gains tax.

The 99.5% Act

The 99.5% Act, proposed by Senator Sanders, will increase the Estate Tax paid by many families. Currently, the Estate Tax Exemption is $11.7 million ($23.4 million for a couple), which has effectively eliminated the Estate Tax for Middle Class Families. Previously, the Estate Tax Exemption was $1 million, as recently as 2003. My clients have welcomed the increase of the Estate Tax Exclusion over the past 17 years. The 99.5% Act includes provisions to:

Reduce the Estate Exemption from $11.7 million to $3.5 million.
Reduce the Unified Gift Exemption from $11.7 million to $1 million per lifetime.
Raise the Estate Tax Rate to a range of 45-65%.
Reduce the Annual Gift Tax Exclusion from $15,000 to $10,000 per donee, AND impose an annual limit of $20,000 per donor.
Reduce certain tax benefits of Trusts, Generation Skipping Trusts, etc.

While I don’t cater to the ultra-wealthy, I do have a number of Middle Class families who this will impact. Ideas in Washington often stick around until they become reality. So, if these Acts don’t get passed now, don’t think that we will never hear them again. I don’t think there will be much empathy for families who have over $1 million in unrealized capital gains. However, in some cases, children will need to sell the houses, farms, and businesses they inherit to pay for these new taxes.

How Many Taxes?

Just to be clear, the Estate Tax is in addition to any Income Tax or Capital Gains Tax. Under the two proposals, an individual who dies with $5 million, would owe a 45% Estate tax on $1.5 million (the amount above $3.5 million). That’s a $675,000 Estate Tax Bill. Then, if their cost basis was $1 million and the unrealized capital gain was $4 million, the heirs would owe another 23.8% on $3 million of capital gains. That would be another $714,000 in taxes, for a total of $1,389,000. Presently, that tax would be zero, so we are talking about a huge increase. Let’s consider eight strategies if the step-up in basis is eliminated and other changes enacted.

Ways to Reduce Taxes under STEP and 99.5% Acts

1. If the Step-Up in Basis is eliminated, you may want to pay your capital gains gradually. Aim to keep your total unrealized gains under $1 million. For example, if you have $2 million in gains, perhaps you could harvest $100,000 of gains for the next 10 years. The goal is for you to pay the gains gradually at the 15% rate and save your heirs from being taxed at the 23.8% rate.

There is a separate proposal from Biden to increase the long-term capital gains rate for taxpayers in the highest tax bracket to 39.6%. Plus you would be subject to the 3.8% Medicare Surtax and state income taxes. And then, capital gains will be taxed at 43.4% to well over 50% in many states. The government would take more than half of your gains! If that happens, it will be vitally important to harvest gains regularly to avoid pushing your heirs into the top bracket.

Roth IRAs

2. Keep your high growth investments in a Roth IRA. Beneficiaries inherit a Roth IRA income tax-free. The Roth 401(k) looks better every year, versus a tax-deferred Traditional 401(k). If higher taxes are ahead, it may be preferable to use the Roth 401(k).

3. Gradually convert your Traditional IRAs to a Roth. By pre-paying the taxes today, you can both shrink the size of your taxable estate and reduce the Income tax burden on your heirs. The current tax rates will expire after 2025. The next five years is a good window to make Roth conversions.

Plan Your Giving

4. Give away your full Annual Gift Tax Exclusion every year. Reduce your Estate. Please note that the direct payment of someone’s medical or education bills does not count towards the annual exclusion. Do not reimburse your children for those expenses – make the payment directly to the doctor, college, etc.

5. If you make charitable donations, give away your most highly appreciated securities, rather than cash. This will reduce your taxable gains. If you do want to leave money to charity, make a charity a beneficiary of your Traditional IRA. If you are over age 70 1/2, you can make charitable donations of up to $100,000 a year from your IRA as Qualified Charitable Donations, or QCDs. QCDs can reduce your taxes so you have more budget to harvest capital gains from taxable accounts. You do not have to itemize to deduct QCDs.

Other Estate Tax Savings

6. Sell your primary residence. A couple, while alive, can exclude $500,000 in capital gains on the sale of their primary residence, as long as they lived there at least 2 of the past 5 years. ($250,000 for single filers.) Let your kids inherit the house and that capital gains exclusion may be lost. Better to sell it yourself and buy another house where you don’t have the big capital gains.

7. Maximize your contributions to 529 College Savings Plans for your children or grandchildren. These will pass outside of your taxable estate and will grow tax-free for the beneficiaries. 529 Plans will not be taxable under any of these proposals, and will become a more important estate planning tool.

8. Life Insurance proceeds are not subject to income tax to the beneficiary. Additionally, If we establish your insurance policy with an Irrevocable Life Insurance Trust (ILIT) as the owner, the life insurance will pass outside of your Estate and not be subject to the Estate Tax. This didn’t matter as much when the Estate Exemption was $11.7 million. ILITs will benefit a lot more families if the Estate Exemption is reduced to $3.5 million. Include the tax benefits, and Permanent Life Insurance looks even better as an asset.

Higher Taxes Ahead?

I am proud to be an American and pay my fair share of taxes. Still, these proposals represent a massive tax increase on a lot of families. Many professional couples have the potential to have over $3.5 million before they pass away, and easily over $1 million in capital gains, too. We will keep you posted on this legislation. It seems likely that the two Acts will be merged and some compromise reached before a final version is up for a vote.

Luckily, there is a lot we can do to offset some of these proposed taxes and reduce the burden on your Estate and Heirs. Last minute strategies won’t work here, though. Families need to be thinking about their transfer of wealth years and decades ahead of time. Have questions on strategies if the step-up in basis is eliminated? Feel free to drop me an email.

What Every Retiree Should Know About the Step-Up in Cost Basis