Step-Up in Basis: Why Dying is the Ultimate Tax Loophole
Step-Up in Basis: Why Dying is the Ultimate Tax Loophole
EXECUTIVE SUMMARY
- The Mechanism: Under IRC ยง 1014, when you inherit an asset (stock, real estate), the IRS resets its “Cost Basis” to the fair market value on the date of the original owner’s death. This is called a Step-Up in Basis.
- The Benefit: This wipes out all embedded capital gains tax liabilities. If your dad bought Apple stock for $1 and it’s worth $200 when he dies, you can sell it for $200 the next day and pay $0 tax.
- Authority Baseline: This analysis follows current federal estate tax laws, which apply the step-up automatically to assets held in a Revocable Trust or individual name at death.
- Scope Limitation: This does NOT apply to tax-deferred accounts like Traditional IRAs or 401(k)s. It only applies to taxable assets (Brokerage, Real Estate, Crypto).
- Anti-Exaggeration: You have to die to use it. It is not a benefit for you; it is a benefit for your heirs.
The biggest mistake elderly parents make is “gifting” their house to their kids while they are alive. “I just want to put your name on the deed,” they say. This innocent act destroys the Step-Up in Basis. By gifting, the kids inherit the parents’ original low cost basis (Carryover Basis), triggering a massive tax bill when they sell. According to Team BMT Analysis, holding assets until death is often superior to selling them during retirement. Source: IRS Publication 551 (Basis of Assets)
Scenario: Dad bought a house in 1980 for $100k. It is now worth $2M.
- Option A (Gift While Alive): Dad gives house to Son.
Son’s Basis: $100k (Carryover).
Son Sells for $2M. Gain: $1.9M.
Tax Bill (Fed+State ~30%): $570,000. - Option B (Inherit at Death): Dad dies. Son inherits house.
Son’s Basis: $2M (Step-Up).
Son Sells for $2M. Gain: $0.
Tax Bill: $0. - Verdict: Doing nothing saved the family half a million dollars.
Tax Liability Comparison
| Transfer Method | Capital Gains Tax Due upon Sale |
|---|---|
| Lifetime Gift (Carryover Basis) | 570000 |
| Inheritance (Step-Up Basis) | 0 |
*Chart Note: The “Step-Up” effectively forgives all capital gains that accrued during the decedent’s lifetime. It is the IRS’s way of avoiding double taxation (Estate Tax + Income Tax), but for 99% of people (who owe no Estate Tax), it is a pure windfall.
CRITICAL SCENARIO: The “Community Property” Advantage
Double Step-Up for Married Couples.
| State Law | Rule |
|---|---|
| Common Law States (NY, FL, etc.) | Only the deceased spouse’s half (50%) gets a step-up. The survivor’s half keeps the old basis. |
| Community Property States (CA, TX, etc.) | 100% of the asset gets a step-up when the first spouse dies. The survivor can sell the entire house tax-free immediately. |
Execution Protocol
Review your portfolio. Do you have Apple stock bought in 1990? A rental property bought in 2000?
Rule: Never sell these. Borrow against them (Securities Line of Credit) if you need cash (Buy, Borrow, Die), but keep the asset until death to erase the tax liability.
To ensure the asset passes smoothly to heirs (avoiding probate) while still qualifying for the Step-Up, hold the title in a Revocable Living Trust.
Warning: Putting assets in an Irrevocable Trust (for Medicaid planning) often removes them from your estate, which forfeits the Step-Up. Be careful.
If you have an ill parent, you can gift appreciated assets to them (if you trust them). When they die a year later, they leave it back to you.
Constraint: IRC ยง 1014(e) says the recipient must live for at least 1 year after receiving the gift for the step-up to apply. If they die next week, no step-up.
WEALTH STRATEGY DIRECTIVE
- Do This: Tell your parents to stop trying to put you on the deed of their house. It creates a tax nightmare. Instead, have them put the house in a Living Trust with you as the beneficiary.
- Avoid This: Selling highly appreciated assets to pay for long-term care if you have other cash sources. Spend your IRA money first (which has no step-up) and preserve the taxable account (which has a step-up) for heirs.
Frequently Asked Questions
Does this apply to Crypto?
Yes. If you die with Bitcoin in your cold wallet, your heirs inherit it with a basis equal to the market price on the date of your death. They can cash out tax-free.
What about 401(k)s?
No. Retirement accounts (IRD – Income in Respect of a Decedent) do NOT get a step-up. Heirs must pay ordinary income tax on withdrawals. This is why you should spend down your IRA and save your Brokerage account.
Is there a limit?
There is no limit on the Step-Up itself, but if your total estate exceeds the exemption ($13.61M in 2024), you will owe Estate Tax (40%). The Step-Up saves Income Tax, not Estate Tax.