Step-Up in Basis

Cost basis is what you're treated as having paid for an asset; sell for more and the difference is a taxable capital gain. Step-up in basis is the rule that, at death, an asset's basis resets to its fair market value on the date the owner died. The heir who sells immediately owes little or no capital gains tax, no matter how enormous the appreciation during the decedent's life. A stock bought for $10,000 in 1985 and worth $500,000 at death passes to the heirs with a $500,000 basis; the $490,000 of lifetime gain is never income-taxed to anyone. The rule (Internal Revenue Code section 1014) was left untouched by the 2025 OBBBA legislation, and it drives more late-in-life planning decisions than almost any other provision in the code.

The sharpest planning contrast is gift versus inherit. Give an appreciated asset during life and the recipient takes carryover basis: your original cost follows the asset, and the built-in gain is taxed when they sell. Let the same asset pass at death and the basis steps up, gain erased. For a highly appreciated asset held by someone late in life, the income-tax math usually argues for holding until death rather than gifting, and it argues even harder against selling shortly before death. (It cuts the other way for assets sitting at a loss: basis also steps down at death, wasting the deductible loss, so loss positions are often better sold during life.)

Community property adds a twist worth real money. In community property states, both halves of community property, the survivor's half included, receive a basis adjustment at the first spouse's death. In common-law states, only the decedent's ownership share steps up. For long-married couples holding appreciated assets, that double step-up can eliminate hundreds of thousands of dollars of taxable gain when the survivor sells.

Know the boundaries. Tax-deferred retirement accounts (traditional IRAs, 401(k)s) never get a step-up; distributions are ordinary income to beneficiaries under inherited-account rules. Annuity gains and other "income in respect of a decedent" items are likewise excluded. And with the federal estate tax exemption at $15,000,000 per person starting in 2026, the overwhelming majority of estates owe no estate tax, which makes the step-up the dominant tax consideration in most families' estate plans: the practical question is rarely "how do we avoid estate tax" and usually "how do we avoid forfeiting the step-up." Heirs should document date-of-death values (appraisals for real estate and businesses) at the time, not years later when records are cold.

A hypothetical example: Helen bought stock for $50,000 that is worth $250,000 when she dies. Her son Alex inherits it with a stepped-up basis of $250,000. If he sells right away at $250,000, his taxable gain is zero; the $200,000 of appreciation during Helen's life escapes capital gains tax entirely. If he holds on and sells later at $260,000, he owes tax on just $10,000.

Rewind the tape: suppose Helen had instead gifted him the shares the year before she died. Alex would take her $50,000 carryover basis, and selling at $260,000 would mean a $210,000 taxable gain, tax on roughly twenty times as much. Same stock, same family, radically different tax bill, purely because of how and when the asset changed hands. This is why the hold-versus-gift question belongs in any plan involving appreciated assets and aging owners, ideally reviewed by a tax-focused planner before anything is transferred.

Pros

• Erases lifetime capital gains on inherited appreciated assets, often the largest single tax benefit a family ever receives.
• Spares heirs the forensic accounting of reconstructing a decedent's decades-old cost basis.
• Community property rules can double the benefit for married couples in those states.
• Pairs with today's high estate tax exemption: most estates owe no estate tax and still get the full basis reset.

Cons

• Rewards holding appreciated assets until death even when selling or diversifying would be the better investment decision, a genuine tax tail wagging the portfolio dog.
• Basis steps down on loss assets, destroying deductible losses that a sale during life would have captured.
• Doesn't apply to retirement accounts, annuity gains, or other income in respect of a decedent.
• Establishing date-of-death values can require appraisals, and sloppy documentation creates disputes with the IRS later.