With the federal estate and gift tax exemption remaining at historically high levels, currently $15 million for 2026, many families are no longer focused primarily on federal estate taxes. Instead, attention has shifted toward income tax planning strategies that can help preserve wealth across generations.
One of the most valuable tools available is the stepped-up basis rule. This provision can significantly reduce the capital gains tax burden on inherited assets, helping heirs retain more of what they receive.
Understanding Capital Gains Tax
When an individual sells an asset for more than its original purchase price, the profit is generally subject to capital gains tax. Common examples include:
- Stocks and bonds
- Investment real estate
- Business interests
- Artwork and collectibles
Assets held longer than one year typically qualify for long-term capital gains treatment. Depending on taxable income, long-term capital gains are generally taxed at rates of 0%, 15% or 20%.
In addition, certain higher-income taxpayers may be subject to the 3.8% net investment income tax.
Short-term gains, which apply to assets held for one year or less, are taxed at ordinary income tax rates that can reach as high as 37%.
A taxpayer’s gain is calculated by subtracting the asset’s tax basis from the sale price. For example, if stock was purchased for $15,000 and later sold for $45,000, the resulting taxable capital gain would be $30,000.
While these rules generally apply when assets are sold during the owner’s lifetime, inherited assets are often treated differently under federal tax law.
Stepped-Up Basis: A Powerful Tax Advantage for Inherited Assets
The stepped-up basis rule adjusts the tax basis of most inherited assets to their fair market value as of the owner’s date of death.
As a result, appreciation that occurred during the original owner’s lifetime is generally removed from future capital gains calculations. Beneficiaries typically pay tax only on the growth that occurs after they inherit the asset.
Assets commonly eligible for a stepped-up basis include:
- Publicly traded securities
- Real estate holdings
- Business ownership interests
- Investment accounts
- Artwork and collectibles
- Personal property
However, retirement accounts such as traditional IRAs and 401(k) plans generally do not receive a stepped-up basis and remain subject to their own tax rules.
Example of How a Stepped-Up Basis Works
Consider the following scenario.
Mary purchases stock in XYZ Corporation for $100,000. Ten years later, at the time of her death, the investment is worth $500,000. She leaves the stock to her son, Todd.
Under stepped-up basis rules, Todd’s basis in the stock becomes $500,000, reflecting its fair market value on the date of Mary’s death rather than her original purchase price.
Two years later, Todd sells the stock for $700,000.
His taxable gain is calculated as:
- Sale price: $700,000
- Adjusted basis: $500,000
- Taxable gain: $200,000
Assuming a 20% long-term capital gains tax rate applies, Todd would owe $40,000 in federal capital gains tax.
Without the basis adjustment, Todd’s taxable gain would have been $600,000, leading to a tax bill of $120,000 at the same rate.
In this example, the stepped-up basis saved $80,000 in taxes.
What Happens When Asset Values Decline?
The rules work differently when an asset loses value before death.
If the fair market value of the inherited asset is lower than the original owner’s cost basis, the beneficiary generally receives the lower date-of-death value as the new basis.
After inheritance:
- A future increase in value could create a taxable gain when sold.
- Continued declines could generate a deductible capital loss, subject to applicable tax rules.
Because market values can fluctuate significantly, understanding basis adjustments is essential when evaluating inherited investments and property.
Estate Planning Considerations for Business Owners
Business owners often hold highly appreciated assets, including company ownership interests, commercial real estate and investment portfolios. In many cases, a stepped-up basis can be a key component of a broader estate planning strategy.
Some planning opportunities include:
- Reviewing ownership structures of business entities
- Evaluating the tax impact of gifting versus retaining assets
- Coordinating estate plans with succession planning objectives
- Assessing how inherited assets may affect beneficiaries’ tax situations
Proper planning can help families preserve more wealth while minimizing unexpected tax consequences.
Maximizing the Benefits of a Stepped-Up Basis
The stepped-up basis remains one of the most valuable tax provisions available for families transferring appreciated assets to the next generation. By resetting the tax basis of qualifying inherited assets, heirs can significantly reduce future capital gains tax exposure while preserving family wealth.
If you own appreciated investments, real estate or business interests, now is a good time to evaluate how stepped-up basis rules fit within your overall estate plan. Contact Landmark CPAs today to discuss estate planning, business succession planning and tax-efficient wealth transfer strategies tailored to your situation.
