The step-up in basis is one of the most valuable yet least understood estate planning tools in the federal tax code. For families with significant appreciated assets, from real estate and investment portfolios to closely held business interests, understanding how this rule works can mean the difference between a tax-efficient inheritance and an unnecessary capital gains bill.
At Q3 Advisors, we incorporate step-up in basis planning into every estate and legacy strategy we build for IRA millionaires and pre-retirees. This guide explains the mechanics of the rule, which assets qualify, and how to use it intentionally in your financial plan.
What Is the Step-Up in Basis Rule?
When you inherit assets, the IRS allows your cost basis to be reset to the fair market value of those assets on the date of the original owner’s death. This reset is known as the step-up in basis, and it is one of the most powerful estate planning tools available under current tax law. For clients working with Q3 Advisors on legacy planning, understanding how step-up in basis interacts with their broader wealth transfer strategy is essential.
In practical terms, if your parents purchased stock 30 years ago for $10,000 and it is worth $200,000 when they die, your inherited basis is $200,000, not $10,000. If you sell that stock the next day, you owe zero capital gains tax on 30 years of appreciation. That is the step-up in basis working in your favor.
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The step-up rule is especially important in the current estate tax environment. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, made the elevated estate tax exemption permanent at $15 million per person ($30 million per married couple) effective 2026, indexed for inflation. Most families therefore have no federal estate tax exposure at all, which means the step-up in basis is the dominant tax mechanic affecting how appreciated assets pass to heirs, not a side consideration alongside an estate tax bill.
How the Step-Up in Basis Works: A Practical Example
To understand the real impact, consider two scenarios for a couple who accumulated appreciated real estate and equities over decades.
Without a step-up in basis, if a beneficiary inherited a rental property with an original purchase price of $150,000 and a current value of $600,000, selling it would trigger capital gains taxes on $450,000 of gain. At the top federal long-term capital gains rate of 20%, plus the 3.8% Net Investment Income Tax, that is potentially $107,100 in federal taxes alone, not including state taxes.
With a step-up in basis, the beneficiary’s basis becomes $600,000. If they sell immediately, they owe nothing in capital gains taxes. The entire $450,000 of accumulated appreciation effectively disappears for tax purposes. This is why the step-up in basis rule is sometimes called the “angel of death loophole” by critics, and a cornerstone of estate planning by advisors.
Which Assets Qualify for a Step-Up in Basis?
The step-up in basis applies to most capital assets included in a decedent’s taxable estate. Common qualifying assets include individual stocks and bonds, real estate (investment properties, vacation homes, even a primary residence), mutual fund shares held in taxable brokerage accounts, closely held business interests, and collectibles such as art, jewelry, and precious metals.
Critically, the step-up does NOT apply to tax-deferred retirement accounts such as traditional IRAs or 401(k)s. Inherited IRAs and 401(k)s are subject to ordinary income tax on withdrawals, not capital gains rates, and most non-spouse beneficiaries are required to empty them within ten years under the SECURE Act. This asymmetry between taxable assets (full step-up) and pre-tax retirement accounts (no step-up, ordinary income to heirs) is the most important planning insight in this entire article, and is covered in its own section below.
A few other notable exceptions and edge cases worth understanding:
- Net unrealized appreciation (NUA) stock has a partial step-up. If you used the NUA strategy to distribute employer stock from a 401(k) to a taxable brokerage account during your lifetime, the post-distribution appreciation gets a step-up at death, but the NUA portion itself is treated as income in respect of a decedent (IRD) and does NOT get a step-up. Heirs pay long-term capital gains tax on the NUA amount when they sell.
- Annuities generally do NOT receive a step-up. Earnings inside a non-qualified annuity are treated as IRD and pass to heirs as ordinary income.
- Roth IRAs receive no step-up, but they don’t need one. Qualified Roth IRA distributions are already tax-free, so heirs withdraw without owing income tax regardless of basis.
For the IRA-millionaire ICP, this asset-by-asset distinction is central to legacy planning. Understanding legacy Roth conversion strategies helps you convert taxable pre-tax IRA dollars into tax-free Roth dollars before death, providing heirs with a different but equally powerful tax advantage.
The Step-Up Asymmetry: Why IRA Millionaires Convert IRAs but Hold Taxable Assets
This is the central planning insight that follows from the step-up rule, and it is the strategic foundation of much of the work we do with IRA millionaires.
Taxable brokerage accounts get a full step-up at death. A $1 million taxable brokerage account with $700,000 of unrealized gains passes to heirs with the basis reset to $1 million. Heirs can sell the entire account the next day and owe zero capital gains tax. The $700,000 of accumulated appreciation effectively disappears.
Traditional IRAs get no step-up. A $1 million traditional IRA passes to heirs with the same pre-tax balance and full income tax liability. Most non-spouse beneficiaries (typically adult children) must distribute the account within 10 years under the SECURE Act. If the heirs are in their peak earning years at a 32% or 35% marginal rate, that $1 million IRA produces only $650,000–$680,000 of after-tax inheritance.
The asymmetry is the planning insight. For most IRA millionaires, the optimal lifetime strategy is the inverse of conventional wisdom:
- Spend down taxable brokerage accounts during your retirement. They get the step-up later, but if you can fund living expenses from them now, you avoid generating taxable income during your peak conversion years.
- Convert traditional IRA dollars to Roth. Pay the tax at your bracket today (often 22-24% in the gap years between retirement and RMDs) rather than passing the bill to heirs at their bracket later (often 32% or higher).
- Hold appreciated taxable assets until death. The step-up wipes out the capital gains liability for heirs. Selling these assets during your lifetime to fund living expenses gives up that step-up.
- Use Roth dollars for the most flexible heir treatment. Inherited Roth IRAs are still subject to the 10-year rule, but distributions are tax-free, so heirs can take a single tax-free lump sum if that is what they prefer.
The bottom-line tradeoff for an IRA millionaire with $2 million in pre-tax IRAs and $2 million in appreciated taxable assets is straightforward: every dollar of IRA you convert to Roth before death saves your heirs roughly 10–15 cents on the dollar in tax (the difference between your bracket and theirs). Every dollar of appreciated taxable asset you DON’T sell before death saves your heirs the full capital gains tax on its appreciation. Both moves capture meaningful value; together, they can preserve hundreds of thousands of dollars across generations.
This is exactly the kind of multi-account, multi-decade planning Q3 Advisors’ Roth conversion services and our multi-year Roth conversion framework are designed to model. For more on how RMDs interact with conversion timing, see critical insights on Roth conversions and RMDs.
Step-Up in Basis and Joint Ownership: Two Common Traps
The step-up rule treats joint ownership differently depending on the relationship between the owners and the state where the property is held. Two situations regularly produce surprises.
Joint tenancy between spouses in non-community-property states gets only HALF a step-up. When spouses hold property in joint tenancy with right of survivorship in a non-community-property state, only the deceased spouse’s half of the property receives a step-up at the first death. The surviving spouse retains the original (often much lower) basis on their half. For a couple in Colorado who bought a $200,000 home now worth $1 million, only $400,000 of basis gets stepped up at the first death. The surviving spouse keeps their $100,000 original basis on their half.
Community property states get a full step-up on both halves. If you live in a community property state, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin, both halves of community property receive a step-up at the first death. The surviving spouse can step up the basis on the entire asset, not just the deceased spouse’s half. This is one of the more meaningful tax advantages of community property states. (Alaska, Tennessee, and South Dakota allow elective community property treatment through opt-in trusts. Florida has enacted a similar statute, though the IRS has not issued formal guidance confirming federal double step-up treatment applies, so the tax benefit there remains unsettled.)
Joint tenancy with non-spouses produces only a partial step-up. A parent who adds an adult child as joint tenant on a brokerage account or real estate transfers half-ownership during life, and at the parent’s death, only the parent’s half gets the step-up. The child retains the original basis on their half. This is one of the most common and expensive estate planning mistakes we see. A revocable living trust or a transfer-on-death deed typically produces a better outcome by avoiding probate while preserving the full step-up.
Planning Strategies That Use the Step-Up in Basis
Smart estate planning leverages the step-up in basis intentionally. Rather than gifting highly appreciated assets during your lifetime (which transfers your low basis to the recipient), consider holding those assets until death to let heirs benefit from the step-up. By contrast, assets with little or no appreciation may be better candidates for lifetime gifting.
A worked example illustrates the difference. If you gift $100,000 of stock that you originally purchased for $20,000, the recipient takes your $20,000 basis (carryover basis). If they sell at $100,000, they owe long-term capital gains tax on $80,000 of appreciation, roughly $12,000 to $19,000 in federal tax depending on their bracket. If you instead hold that same stock until death and pass it through your estate, the recipient’s basis becomes $100,000. Selling at $100,000 produces zero capital gains tax. The step-up effectively creates an $80,000 tax-free outcome that the lifetime gift is sacrificed.
Another strategy involves using appreciated assets for charitable giving. Donating appreciated securities directly to charity or a donor-advised fund avoids the capital gain entirely and provides a deduction at fair market value. This can be more tax-efficient than selling, paying taxes, and then donating cash. For more on coordinating charitable giving with retirement income, see our QCD guide.
For broader context on how the step-up fits into estate planning, see our guide to tax-saving tips for estate planning and Roth conversions and our coverage of inherited IRA rules and tax strategies and the 10-year rule for inherited Roth IRAs.
Frequently Asked Questions About Step-Up in Basis
Does the step-up in basis apply to Roth IRAs?
No. Roth IRA assets do not receive a step-up in basis. However, qualified Roth IRA distributions are already tax-free, so heirs who inherit a Roth IRA can withdraw the funds without owing income tax. The step-up rule matters most for taxable (non-retirement) accounts where capital gains tax would otherwise apply.
Why don’t traditional IRAs get a step-up in basis?
Traditional IRA assets were funded with pre-tax dollars and grew tax-deferred. The IRS treats inherited traditional IRA distributions as income in respect of a decedent (IRD), taxable as ordinary income to the heir, just as the original owner would have been taxed. Allowing a step-up on these accounts would effectively zero out tax on a lifetime of pre-tax compounding, which is not the policy intent. This is why pre-mortem Roth conversions are such a powerful legacy strategy: they convert pre-tax IRA assets (no step-up, ordinary income to heirs) into Roth assets (no step-up needed, tax-free to heirs).
What happens to the step-up in basis if Congress changes the law?
The step-up in basis has faced proposed elimination or modification several times over the decades. None of those proposals have passed. The OBBBA in 2025 did not change the step-up rule. Working proactively with an advisor to evaluate your estate structure, charitable giving, and conversion opportunities is especially important in periods of legislative uncertainty. Q3 Advisors monitors tax law developments closely and adjusts client planning accordingly.
Can you get a step-up in basis on assets held in a revocable living trust?
Yes. Assets held in a revocable living trust are still included in the grantor’s taxable estate at death and therefore qualify for the step-up in basis. This is one of the main reasons a revocable trust is the preferred probate-avoidance structure for appreciated taxable assets. Irrevocable trusts are more complex and may or may not qualify depending on the trust structure and whether the assets are included in the taxable estate.
Does the step-up in basis apply to gifts made before death?
No. Assets gifted during your lifetime use a carryover basis, meaning the recipient inherits your original cost basis. Only assets transferred at death receive the step-up. This is why gifting highly appreciated assets during your lifetime is often a tax-disadvantaged strategy compared to holding them until death.
Does NUA stock get a step-up at death?
Partially. If you used the net unrealized appreciation strategy to distribute employer stock from a 401(k) to a taxable brokerage account during your lifetime, only the post-distribution appreciation receives a step-up at death. The original NUA portion is treated as income in respect of a decedent (IRD) and does NOT get a step-up, heirs who sell the inherited shares pay long-term capital gains tax on the NUA amount, just as the original owner would have. This makes NUA stock a middle ground between regular brokerage assets (full step-up) and traditional IRAs (no step-up, ordinary income).
Work With Q3 Advisors on Your Estate and Legacy Plan
The step-up in basis rule is just one piece of a comprehensive estate planning strategy. For IRA millionaires and high-net-worth families, coordinating which assets to hold, which to convert, and how to structure your estate for maximum tax efficiency requires personalized guidance. Q3 Advisors specializes in exactly this type of planning. Founder Craig Wear, CFP®, works directly with clients to structure estates that minimize taxes for both the original owner and their heirs.
To schedule a consultation, call (720) 730-5650 or visit our contact page. You can also explore our full range of financial planning services or read answers to common questions about working with Q3 Advisors.
