Understanding the Step-Up in Basis and Your Estate
Estate planning can be complicated, especially when it comes to the “step-up in basis” rules. These rules play a big role in determining the after-tax value of your assets when you pass away. Here’s a plain English guide to how they work and what it means for your heirs.
What is Step-Up in Basis?
When you buy an asset like stocks or property, you have a “basis” – basically what you paid for it. If the asset increases in value and you sell it, you owe tax on the gain between your original basis and the sale price. However, when you die, the tax rules often “step up” the basis to the current market value. This eliminates the embedded gains, allowing your heirs to sell immediately without owing capital gains tax.
Joint Assets Only Get a Partial Step-Up
Many married couples hold assets jointly. But this can limit the step-up for the survivor. Say you bought stock for $100,000 that is now worth $300,000. In community property states, the step-up would be the full $300,000 when the first spouse dies. But in other states, only the deceased spouse’s half gets stepped up – so your basis would only increase by $150,000.
Strategic Planning Can Achieve a Full Step-Up
By shifting appreciated assets into accounts owned only by the spouse expected to die first, couples can obtain a full step-up. This takes coordination but can provide substantial tax savings. Even gifting certain assets can work.
High Federal Exemptions Persist
Despite calls for change, federal estate and gift tax exemptions remain very generous – $12 million per person. Effective planning can shield over $24 million for a married couple. While exemptions may drop in 2026, taxes likely won’t impact most heirs anytime soon.
The step-up in basis is an important piece of the estate planning puzzle. Strategic ownership and transfer of assets can minimize gains taxes for your heirs. With some guidance on the rules, your family can benefit from substantial savings.
Case Study:
The Thompsons and the Step-Up in Basis
Meet Charlie and Sabrina Thompson, a married couple living in Virginia, a separate property state. Over the years, they have accumulated significant assets, including a jointly owned taxable brokerage account with stocks valued at $500,000. This account mainly holds shares of Maple Inc. which they purchased for $200,000 ten years ago.
The Situation
Sadly, Charlie recently passed away. Since Virginia is a separate property state, Charlie and Sabrina each owned 50% of the Maple Inc shares purchased for $200,000. On the date Charlie died, his half of the Maple Inc. stock was valued at $250,000.
The Step-Up in Basis Impact
According to the step-up in basis rule, the basis of Charlie’s share of the Maple Inc. stock is “stepped up” to its market value on the date of his death – $250,000. This gets added to Sabrina’s original basis of $100,000 in her half of the shares.
The Outcome
After Charlie’s passing, Sabrina’s total basis in the Maple Inc. shares is now $350,000 ($250,000 from Charlie’s share + $100,000 of her original basis). If Sabrina were to sell the shares at their current market value of $500,000, she would only need to pay capital gains taxes on $150,000 ($500,000 – $350,000) versus the $300,000 if Charlie had not died.
Case Study:
The Martins and the Individual Ownership Step-Up in Basis
Meet Robert and Emily Martin, a married couple from Florida, each with assets owned individually. Robert solely owned a beachfront property purchased 20 years ago for $300,000. He held this in his personal revocable living trust. Emily separately owned a vintage car collection valued at $400,000 under her name.
The Situation
Unfortunately, Robert recently passed away. At the time of his death, his beachfront trust property had appreciated significantly to $1 million. Since this asset was owned by Robert’s trust, how would the step-up in basis rule apply?
The Impact
Because Robert held the beachfront property in his revocable trust, the full $1 million value becomes part of his estate at death. This qualifies the entire property for a complete step-up in basis to its date-of-death value of $1 million.
The Outcome
After Robert’s death, the trust property’s new basis is $1 million. If Emily sells it for $1 million, she would owe no capital gains taxes because the property’s basis equaled the sale price. However, Emily’s car collection stays in her name with no change. It would only receive a step-up in basis if she passes away.
For a personalized approach to navigating your estate planning journey, don’t hesitate to reach out for a consultation.
