Capital gains taxes can significantly affect how much wealth is actually transferred when assets pass from one generation to the next — and one of the most valuable provisions in the federal tax code for estate planners is the step-up in basis that applies to inherited assets. Understanding how this rule works, when it applies, and how it interacts with other aspects of an estate plan is essential for families who hold appreciated assets and want to minimize the tax burden on the next generation.
Mandelbaum Barrett PC’s trusts and estates practice advises New Jersey and New York families on estate planning strategies that take full advantage of available tax rules, including the step-up in basis and the planning techniques that can maximize its benefit. The firm’s attorneys help clients evaluate when holding appreciated assets until death produces better tax outcomes than transferring them during life, and when other strategies are preferable.
How the Step-Up in Basis Works
When a person dies holding appreciated property, the income tax basis of that property is stepped up to its fair market value as of the date of death. This means that an heir who receives property under the stepped-up basis rules and immediately sells it will owe little or no capital gains tax, even if the property had increased substantially in value during the decedent’s lifetime. The step-up effectively eliminates the embedded capital gain that existed on the date of death.
Consider a concrete example: if a parent purchased shares of stock for $10,000 and those shares are worth $100,000 at the time of the parent’s death, the heir’s basis in those shares becomes $100,000. If the heir sells the shares immediately after inheriting them, the taxable gain is zero. If the parent had instead gifted the shares during life, the heir would take the parent’s original $10,000 basis and would owe capital gains tax on the full $90,000 gain upon sale. The difference in tax outcome is substantial, and it is one of the core reasons why the form of a wealth transfer — gift versus bequest — matters so much to an estate plan’s overall tax efficiency.
Planning Implications for Appreciated Assets
The step-up in basis has important implications for how families should think about transferring appreciated assets. A gift of highly appreciated property during the donor’s lifetime transfers the asset’s embedded gain to the recipient along with the asset itself. Allowing the same asset to pass through the estate at death resets the basis and eliminates that gain entirely.
This dynamic affects decisions across a range of estate planning techniques. Families considering irrevocable gifts to trusts, annual gifting programs, or lifetime wealth transfer strategies need to weigh the capital gains implications against the estate tax savings those transfers may generate. For families whose estates are below the federal estate tax exemption threshold, the step-up in basis argument for holding appreciated assets until death can be compelling because there is no estate tax liability to offset it.
According to the Internal Revenue Service, the rules governing the basis of inherited property are set forth in IRS Publication 559, and the application of those rules can vary depending on the specific circumstances, including whether the decedent held property individually, in trust, or as community property with a surviving spouse.
Contact Mandelbaum Barrett PC for Estate Planning Guidance
If your family holds appreciated assets and you want to understand how the step-up in basis and other tax rules should shape your estate plan, the trusts and estates team at Mandelbaum Barrett PC can help.
Reach out through our contact page to speak with our attorneys. We are here to help New Jersey and New York families design estate plans that minimize tax liability and preserve as much wealth as possible for future generations.