At Wilder Wealth Strategies, we’re always looking for opportunities to help you optimize your financial plan. One little-known but incredibly powerful tool in the tax code is the step-up in basis—a hidden gem that can have a major impact on your legacy.
A step-up in basis is a tax provision that applies when you inherit assets like stocks, bonds, mutual funds, or ETFs from someone who has passed away. The step-up resets the value of the asset to its market value on the date of the original owner’s death—so if you inherit an asset that has grown in value over time, you avoid paying a capital gains tax on the increase that occurred while the original owner held the asset.
Let’s say your parents bought Apple stock years ago at $30 per share. Today, it’s worth $251 per share. If they pass away and leave that stock to you, you’ll get a “step-up” to $251, the value of the stock on the day they passed. That means you won’t have to pay capital gains tax on the $221-per-share increase that happened during their lifetime.
This might sound too good to be true, but it’s a legitimate part of the tax code. Most assets you inherit (apart from life insurance and Roth accounts) will come with a tax consequence, but the step-up in basis allows you to sidestep those taxes for certain investments.
That's a rare gift in the world of taxes.
For a step-up in basis to apply, the asset needs to be in a non-retirement account (i.e., not an IRA or 401(k)). It can be an individual or joint account, and it doesn’t matter whether the asset is stocks, mutual funds, or ETFs, as long as it’s outside of retirement accounts.
Even in a joint account, if one account holder passes away, the surviving account holder may receive a partial step-up on the deceased person’s share of the assets. For example, if a couple has a $1 million investment account with a $400,000 basis, and one of them dies, the surviving spouse could receive a step-up on half of the account’s value—even though they’re an original owner of the account.
(However, this rule only applies in non-community property states. So, if you’re in a community property state, things might look a bit different.)
The best way to ensure the step-up in basis works as smoothly as possible is to set up a Transfer on Death (TOD) registration. With a TOD, the asset automatically transfers to the beneficiary upon the owner’s death—no probate required—and the beneficiary gets the stepped-up basis.
While the step-up in basis is a great benefit, it’s not the be-all, end-all of financial strategies. Unlike IRAs or 401(k)s, which allow you to move assets around without tax consequences, non-retirement accounts have more tax implications and therefore require more consideration when it comes to buying, selling, and transferring assets.
For instance, I’m working with a couple right now, and they’re approaching retirement. They’ve held some stocks for years, and their basis is extremely low. They told me, “If we can live comfortably with our other assets, we’d prefer to leave these stocks to our kids, so they can receive the step-up benefit.” This is a smart strategy if they don’t need to sell those assets to generate income.
But if they do need income from those assets, selling them will trigger a capital gains tax. So they have to consider whether it makes sense to hold onto the assets for tax purposes, or if there is more benefit to selling them now to meet their income needs.
In this scenario, it’s important to remember that, for many retirees, death is still a long time away—often 20 or 30 years down the road. So even if you need to diversify to meet your income needs—and that means paying taxes today—your portfolio still has plenty of time to appreciate and create a low basis for your heirs.
A concentrated stock position might be a winning strategy when you’re young, but as you approach retirement, it becomes riskier and riskier—after all, we’ve all seen well-known names become nothing in the market. So while it may be tempting to hold onto a high-growth asset, you also need to consider whether diversification could give you more stability and income potential.
Similarly, if you’re young and want to do more in retirement—travel, take the entire family on a vacation, buy a boat, whatever—selling some stocks gradually (and paying the taxes now) could give you more freedom to enjoy those things.
Other investors hold onto stocks because they’re emotionally attached. Maybe it’s a “pet stock” they’ve had for years, or one that was inherited from a loved one. While sentimental value can make it hard to sell, it’s important to keep your needs and goals in mind and decide whether holding or selling is the best choice.
The step-up in basis is a valuable tool, but it should not drive your entire financial strategy. After all, your financial plan is about more than tax mitigation—it’s about making smart decisions for your life today and creating a legacy that reflects your values.
If you’re thinking about how to best manage your non-retirement accounts, I’d love to help. Together, we can ensure your financial decisions align with your goals for today and the future.
Neither Wilder Wealth Strategies, LLC nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.