Why Tax and Estate Planning Matters: The Step-Up in Basis Explained

When it comes to passing wealth to the next generation, details matter – and few details carry more weight than how assets are transferred. Real estate is often one of the most valuable assets a family owns, and the way it’s passed on can have enormous tax implications.

Let’s look at a simple example:

• You purchase a home for $200,000.
• By the time you pass away, that home is worth $1,000,000.

If your children inherit the property after your death, they generally receive what’s called a “step-up in basis.” This means their tax basis in the home is “stepped up” to its fair market value at the time of your passing – in this case, $1,000,000.

What does that mean in practice? If your children sell the home right away for $1,000,000, they owe no capital gains tax because the sale price equals their stepped-up basis.

Now, let’s look at a different scenario. Suppose you decide to gift the home to your children shortly before passing. In that case, they inherit your original basis of $200,000 – not the current $1,000,000 value. If they sell the home for $1,000,000, they could face tax on $800,000 in gains.

The difference between those two outcomes? Potentially hundreds of thousands of dollars in unnecessary tax.

What Is the Step-Up in Basis?

The step-up in basis is a rule in the U.S. tax code that adjusts the value of an inherited asset to its fair market value on the date of the original owner’s death. This new “stepped-up” basis becomes the starting point for calculating capital gains taxes if the heir decides to sell the asset.

A few key facts to know:

• It applies broadly: The step-up in basis generally applies to assets like real estate, stocks, bonds, mutual funds, and other investments.
• It erases past gains: Any unrealized appreciation (growth in value during the original owner’s lifetime) effectively disappears for tax purposes at death.
• It can save heirs significant money: If the asset is sold soon after inheritance, little to no capital gains tax may be owed.
• Married couples may benefit twice: In community property states, both halves of community property can receive a step-up when one spouse passes, not just the decedent’s portion.
• It doesn’t apply to all assets: Certain items, like retirement accounts (IRAs, 401(k)s) and annuities, don’t get a step-up in basis. Those are subject to different tax rules.

How Smith Haughey Can Help

This is where a law firm with both tax and estate planning experience becomes invaluable. Attorneys who understand both sides of the equation can:

• Evaluate your assets to identify where step-up in basis rules apply.
• Develop strategies to minimize capital gains tax for your heirs.
• Coordinate timing and method of transfers (such as gifting vs. inheritance) to align with your overall estate plan.
• Educate your family so beneficiaries understand the tax implications when inheriting assets.
• Integrate tax planning into your broader estate goals, ensuring you not only pass on assets but also preserve as much of their value as possible.

Estate planning isn’t just about deciding who gets what—it’s about making sure your legacy is transferred as efficiently and thoughtfully as possible. Without the right planning, well-meaning decisions like gifting property at the wrong time can have unintended financial consequences.

Coordinating your tax and estate plans ensures your family keeps more of what you’ve earned—and the legacy you intended to leave behind.

Connect with the experts at SHRR today to ensure your estate plan is set up for success.