The Tax Loophole That Can Save Families Thousands

Step-Up in Basis: The Little-Known Tax Loophole That Can Save Families Thousands

There is a powerful—but often misunderstood—loophole in the income tax system that can save families an enormous amount of money when a loved one passes away. It’s called the step-up in basis, and it can completely eliminate decades of built-up capital gains taxes.

At Yanowitz Law Firm, PLLC, we’ve helped families reduce taxes and protect their estates for more than 30 years. Today, we want to explain how the step-up in basis works and why it can be an invaluable tool in your estate planning strategy.

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How the Step-Up in Basis Works

To understand the step-up in basis, imagine someone buys an asset—such as stock, farmland, rental property, or a family cabin—for $10. Over time, that asset appreciates, and by the end of their life, it is worth $18.

If they were to sell the asset during their lifetime, they would owe income tax on the $8 of appreciation. But something very different happens if they continue to own the asset until death.

When someone dies owning appreciated property, the tax basis of that asset is reset to its fair market value on the date of death. This means:

  • The old basis disappears.

  • The basis “steps up” to the current value.

  • If the family sells the asset soon after death, they may owe little or no income tax.

In the example above, instead of the family paying taxes on $8 of appreciation, their new tax basis becomes $18—the full fair market value. If they sell the property for around $18 after death, there is no taxable gain.

This is why the step-up in basis is sometimes called a “get-out-of-jail-free card” for capital gains taxes.

Why This Matters for Families With Highly Appreciated Assets

Many clients come to us later in life wanting to simplify their estates. They may say:

  • “I want to give my cabin to my kids now.”

  • “I don’t need all these assets anymore.”

  • “I’d like to gift some investments while I’m still living.”

But if the asset has significantly appreciated and the person is older or in declining health, giving it away during life may actually cost the family thousands of dollars in capital gains taxes.

This often happens with:

  • Family cabins purchased decades ago

  • Farmland or investment inherited decades ago

  • Long-held stocks that have grown tremendously

  • Rental properties with low original purchase prices

When someone gifts an asset during life, the recipient receives the donor’s old (low) basis. But if the person holds onto the property until death, the family receives a new stepped-up basis at fair market value.

In other words:

Gifting highly appreciated property during life = family pays large capital gains taxes.
Letting heirs inherit the property at death = capital gains may be erased entirely.

This is why timing matters so much.

When to Gift and When to Hold

Every situation is unique, but here are some general guidelines:

You may want to HOLD an appreciated asset if:

  • You bought it decades ago and it has grown significantly

  • You are older or your life expectancy has changed

  • You want your heirs to benefit from a full step-up in basis

You may consider GIFTING an asset during life if:

  • It has not appreciated much

  • You need to remove the asset from your estate for estate tax reasons

  • Your heirs need the property now for personal or financial reasons

  • You expect the property to grow a lot in the future

Before making a large gift—including real estate or significant stock transfers—it’s wise to evaluate how the step-up in basis could affect your family’s taxes. For many clients, holding appreciated assets until death results in substantial tax savings.

Protect Your Estate With Informed Planning

The step-up in basis is one of the most valuable tools available in estate planning. Used correctly, it can eliminate decades of unrealized capital gains and allow families to preserve more of their wealth as it transfers from one generation to the next.

If you want to better understand how this rule applies to your situation—or whether you should gift or retain certain assets—our team at Yanowitz Law Firm, PLLC is here to help. With more than 30 years of experience navigating tax and estate laws, we guide families every day in making smart, tax-efficient decisions.

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Frequently Asked Questions

 
What kinds of assets qualify for a step-up in basis?

Most capital assets—such as real estate, investment property, stocks, and certain business interests—receive a step-up in basis when inherited. Retirement accounts like IRAs do not receive a basis adjustment.

Should I stop gifting appreciated property during my lifetime?

Not necessarily. Gifting may be appropriate for estate tax planning or family reasons. However, before gifting property with significant appreciation, always consider the potential capital gains your heirs would face.

Does the step-up in basis apply to married couples?

Yes. In many states, including Minnesota, assets owned jointly by spouses may receive a partial or full step-up in basis when the first spouse dies, depending on how the property is titled and where the property is located.

Author

Claire creates wills and trusts which provide security and peace of mind. She compassionately listens to her clients’ dreams, goals, and fears and then fashions plans that best meet their needs. It is important to Claire that her clients understand different options and make decisions that are right for them. She loves to educate clients by drawing out complicated concepts.

Come visit us! Conveniently located in Rochester, Minnesota.

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Further Reading: NAEPC Journal of Estate & Tax Planning