What is the “step-up” in basis?

This article builds on the post from last month which provides an introduction to the basic concepts related to tax basis. Access that article here to learn more.
 
A significant part of the estate planning process is determining how and when to distribute a person’s assets among their friends and loved ones, as well as to charitable and other organizations. If a person has any appreciated assets (assets that have increased in value beyond the person’s basis in them), the so-called “step-up” in basis may come into play within the estate plan. This article will introduce the tax rule known as the step-up in basis and explain some of the ways in which it should be considered during the estate planning process.
 
What is a “step-up” in basis?
In most cases, when the owner of an asset leaves it to someone else upon their passing, the recipient’s basis in the asset is the fair market value of the asset on the date of the owner’s death. Since many assets tend to appreciate over time, the result is that the recipient’s basis is often higher than the original owner’s basis. This increase in basis in an asset upon the death of the original owner is called a “step-up” in basis.
 
The importance of a step-up in basis arises when the recipient sells the asset. Because capital gains (and losses) are measured using the difference of the sale price of an asset and the basis, having a higher basis means that the recipient will realize a smaller capital gain (or a larger loss) and thus have a smaller capital gains tax burden. For a highly appreciated asset, this could lead to significant tax savings.
 
As discussed in a previous article, the owner of an asset generally must expend money – either by paying taxes or paying for improvements – to increase their basis in a piece of property. The step-up in basis that occurs at death is one of the few ways that basis can be increased without incurring any costs, so it represents a special opportunity to save on taxes through careful planning.
 
How can the step-up in basis affect estate planning?
When a person has an asset that they want to eventually give to someone else, there are basically two options for when to transfer the asset: either during the owner’s lifetime – as a gift – or upon the owner’s passing. As discussed previously, when a person receives an asset as a gift, the recipient’s basis in the asset is the same as the original owner’s. However, when an asset is transferred upon the owner’s death, the recipient gets a step-up in basis.
 
This means that the recipient of a lifetime gift who then sells the asset will owe the same capital gains taxes that the original owner would have owed on the sale. In contrast, the recipient of an asset transferred at death will only ever owe capital gains taxes on appreciation that occurs after the original owner’s death – all of the capital gains taxes that would have been due if the original owner had sold the gift during their lifetime never arise because of the step-up in basis.
 
For example, suppose that "A" purchased some stock in 2007 for $15,000.00 and that the stock has appreciated to a value of $70,000.00 in 2025. A plans to give the stock to her son "B" at some point. If A gives the stock to B as a gift during A’s lifetime, B will get the same basis in the stock that A has: $15,000.00. That means that if B then sells the stock for $70,000.00, B will be realizing a capital gain of $55,000.00, potentially incurring capital gains taxes of upwards of $11,000.00. If A instead decides to keep the stock for the rest of her life and leave it to her son, B’s basis in the stock will be the fair market value of the stock on the date of A’s death. If this value is $80,000.00, B will then be able to sell the stock for up to $80,000.00 without realizing any capital gains, and B will only potentially owe capital gains tax on appreciation beyond that value. Thus, A can give B the same shares of the same stock, but by waiting until A’s death before making the transfer, B can enjoy significant tax savings. The primary trade off is that B has to wait until after A's passing before accessing any funds from the sale of the stock.
 
This example illustrates the fact that, from the perspective of capital gains, transferring a highly appreciated asset at death can lead to substantial tax savings when compared to gifting the same asset during the original owner’s lifetime, as long as the person receiving the gift can afford to wait for it.
 
Is there ever a “step-down” in basis?
It is also important to understand that when the original owner’s basis in an asset was higher than the fair market value of the asset on the date of the owner’s death, the recipient’s basis in the asset will be lower than the original owner’s was. This is called a “step-down” in basis. While less common, a step-down in basis is disadvantageous to the recipient, so if the owner of an asset has a basis in the asset that is much higher than the asset’s fair market value, the owner should probably consider selling off or gifting the asset during life.
 
Does cost basis matter in all cases?
As a final note, if the recipient of an asset never sells it off, no capital gains taxes will be incurred, so having a higher or lower basis in the asset will not affect the recipient’s income tax liability. An example of this might be a situation in which the asset is a house and the recipient intends to continue living in the house indefinitely.
 
If you are interested in learning more about how the step-up in basis should be considered in connection with your estate plan, contact us today to schedule a consultation.
 
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This article is intended for informational purposes only and not for the purpose of giving legal advice for a specific person or situation. Nothing in this article should be taken as legal advice, and reading it does not create an attorney-client relationship.