The “Step-Up in Basis” Rule: Save Thousands on Capital Gains Tax
One of the most common questions I get as a CPA is, “Should I put my house in my kids’ names while I’m alive?” My answer is almost always a screaming “NO!” If you gift your house now, you gift your low “tax basis” (purchase price). When your kids sell it, they will owe massive Capital Gains Tax. But if they inherit it after you die, the IRS gives them a magical gift called the “Step-Up in Basis.” The value of the asset resets to the market value on the day of your death, wiping out decades of capital gains tax liability instantly. Here is the math that saves families hundreds of thousands of dollars.
The Magic Number: When heirs sell an inherited home immediately, the capital gains tax due is typically $0.00 thanks to the Step-Up Rule.
Image Source: bestmoneytip.com
1. The Concept: The “Magic Eraser”
Capital Gains Tax is calculated on the difference between what you sold it for and what you bought it for (Basis).
• While Alive: Your “Basis” is what you paid (e.g., $100k in 1980).
• At Death: The “Basis” automatically resets (steps up) to the Fair Market Value (e.g., $1M in 2026).
• Effect: All the appreciation ($900k) that happened between 1980 and 2026 becomes tax-free forever.
2. The Calculation: Don’t Make a $200k Mistake
Let’s look at the numbers. Parents bought a house in California in 1990 for $100,000. It is now worth $1,100,000.
| Scenario | A. Gifted While Alive | B. Inherited at Death |
|---|---|---|
| Child’s Cost Basis | $100,000 (Carryover) | $1,100,000 (Stepped-Up) |
| Sale Price | $1,100,000 | $1,100,000 |
| Taxable Gain | $1,000,000 | $0 |
| Est. Tax Bill (Fed+State) | ~$250,000 – $330,000 | $0 |
*Assumes ~20% Federal + ~13.3% CA State Tax on $1M gain. Scenario B is the clear winner.
3. What Gets the Step-Up? (And What Doesn’t)
Not every asset enjoys this privilege.
- Real Estate: Primary home, rentals, vacation homes.
- Brokerage Accounts: Stocks, ETFs, Mutual Funds, Crypto held in taxable accounts.
- Physical Assets: Gold, Art, Collectibles.
- Retirement Accounts: Traditional IRAs and 401(k)s do NOT get a step-up. They are taxed as ordinary income to the heir.
- Annuities: Most annuities do not get a step-up.
4. Advanced Tip: The “Double Step-Up”
If you live in a Community Property State (AZ, CA, ID, LA, NV, NM, TX, WA, WI), you get a massive bonus.
- Common Law States: Only the deceased spouse’s half (50%) gets a step-up. The survivor’s half keeps the old basis.
- Community Property States: 100% of the asset gets a step-up when the first spouse dies. The survivor can sell the house immediately with $0 tax.