How The Wealthy Pass down Wealth without paying the IRS: The Power of Step-Up In Basis

Introduction

If you’ve inherited real estate, a business, or a stock portfolio, you might have heard the term step-up in basis thrown around in estate planning conversations.

But what does it actually mean? And more importantly, how can it work to your advantage?

This rule is one of the most powerful tools in the Internal Revenue Code for preserving family wealth, especially for those holding highly appreciated assets. It can reduce, or even eliminate, capital gains tax on inherited property.

At Echelon Financial, we advise clients with estates ranging from $2M to $50M, often involving decades of asset growth. I’ve seen firsthand how strategic planning around the step-up in basis can mean the difference between preserving generational wealth or triggering an unnecessary tax hit.

In today’s post, I’ll walk you through:

  • How the step-up in basis rule works
  • Real-world examples that show its tax-saving potential
  • IRS rules and exceptions you must know
  • Legislative proposals that could limit this benefit
  • Planning strategies to take full advantage of it while it still exists

Let’s break it down.

When you inherit a capital asset — like a home, stock, or business interest — the IRS usually gives that asset a new tax basis equal to its fair market value (FMV) on the date of the original owner’s death. This adjustment is known as a step-up in basis, and it’s codified under Internal Revenue Code §1014.

So why does this matter?

Capital gains tax is calculated based on the difference between your selling price and your cost basis. When that basis is “stepped up” to current market value, much or all of the prior appreciation disappears for tax purposes.

Here’s how it works:

  • Your mom bought a home in Austin for $300,000 in 1990
  • She passes away in 2025, and the home is now worth $900,000
  • Thanks to IRC §1014, your cost basis as the heir becomes $900,000
  • If you sell the home soon after for $900,000, there is no capital gain — and no tax due

Compare that to a gift made to you during your mom’s lifetime:

  • Your basis would have been her original $300,000
  • Sell for $900,000, and you’d pay capital gains tax on $600,000

The takeaway: Inheritance gives you a higher basis which is beneficial for tax purposes. Gifts do not.

This rule applies to most capital assets:

  • Residential or commercial real estate
  • Stocks and bonds
  • Mutual funds
  • Collectibles (like art or antiques)
  • Ownership interests in a family business

But it doesn’t apply to everything. Assets like traditional IRAs and 401(k)s do not receive a step-up in basis. Instead, they are treated as “income in respect of a decedent” and taxed as ordinary income when the beneficiary takes distributions.

Understanding which assets receive this benefit is critical. For those who inherit appreciated property, the step-up in basis can mean the difference between owing nothing and owing hundreds of thousands in taxes.

Over time, most assets increase in value. Families who hold onto real estate, businesses, or investment portfolios for decades often see significant unrealized gains accumulate. These gains represent a large tax liability if the asset is ever sold.

But the step-up in basis rule can eliminate that liability entirely.

Without this rule, heirs would inherit the original owner’s cost basis. That means if they later sell the asset, they could be taxed on gains that occurred during someone else’s lifetime — even decades earlier. In many cases, that tax bill could be in the hundreds of thousands or even millions of dollars.

With a step-up in basis, here’s what happens:

  • The asset’s cost basis resets to its market value on the date of death
  • Capital gains that occurred during the original owner’s lifetime are never taxed
  • The heir can sell the asset with little or no tax owed, depending on post-inheritance appreciation

This has a huge impact on wealth preservation.

Here are the primary benefits:

  • Avoids capital gains tax on decades of appreciation
  • Triggers long-term capital gains treatment automatically, even if the asset is sold right away
  • Reduces the burden of documentation — heirs don’t need to track down decades-old records for original cost, improvements, or adjustments
  • Preserves full market value of the asset for the inheritor, rather than seeing a large portion go to taxes

For high-net-worth families, this rule is a cornerstone of multi-generational planning. It allows wealth to pass cleanly to the next generation without triggering capital gains tax.

That’s why tax advisors often refer to the strategy as “buy, borrow, die.”

  • Buy: The asset is purchased and held for decades.
  • Borrow: The owner may borrow against the asset during life rather than sell (to avoid triggering gain).
  • Die: At death, the asset passes to heirs with a stepped-up basis, erasing the lifetime gains.

Whether it’s an Austin home, an appreciated stock portfolio, or a multi-generational business, the step-up in basis rule protects more of your legacy from unnecessary taxation.

Let’s look at three situations where step-up in basis made a big difference:

  1. Inherited Family Home

Angela bought a home for $50,000 in 1975. At her death in 2025, it’s worth $500,000. Her daughter, Mary, inherits it and sells it a year later for $525,000.

With step-up:

  • New basis: $500,000
  • Taxable gain: $25,000
  • Estimated tax (20%): $5,000

Without step-up (gifted during life):

  • Basis: $50,000
  • Taxable gain: $475,000
  • Estimated tax: $95,000
  1. Inherited Stock Portfolio

Jane bought 1,000 shares of Apple at $10. When she passed away, they were worth $150 each. Her son, Mark, inherits and sells them for $155.

With step-up:

  • Basis: $150,000
  • Sale proceeds: $155,000
  • Taxable gain: $5,000

Without step-up:

  • Basis: $10,000
  • Gain: $145,000
  • Tax: $29,000
  1. Family Farm or Business

The McDowell family farm in Texas has appreciated over four generations. If passed at death, the basis is reset. But if transferred during life, the heir could face tax on over $3 million in gain.

For farms or businesses that are asset-rich but cash-poor, the step-up is what often keeps the business in the family.

The step-up in basis rule is incredibly valuable—but it doesn’t apply to every asset, and it comes with important rules that can affect how much tax your heirs will (or won’t) owe.

Before assuming every inherited asset qualifies, it’s essential to understand the key exceptions and edge cases:

  1. IRAs and 401(k)s
    These tax-deferred retirement accounts do not receive a step-up in basis.
  • Instead, they are treated as “income in respect of a decedent” (IRD)
  • Withdrawals by heirs are taxed as ordinary income, not capital gains
  • There is no adjustment to fair market value at death
  1. Income in Respect of a Decedent (IRD)
    This category includes any income the deceased was entitled to but hadn’t yet received. Examples:
  • Accrued interest on savings accounts
  • Final paychecks
  • Uncollected dividends
  • Unpaid rent or royalties

Heirs must pay income tax on these amounts. There is no step-up.

  1. One-Year Gift Rule (IRC §1014(e))
    This rule closes a potential loophole. If you gift appreciated property to someone and they pass away within one year, and you then inherit the same asset back, no step-up is allowed.
  • You retain your original basis
  • This rule only applies when the gift loops back to the original giver
  1. Community Property States
    In states like Texas, California, Arizona, and others that follow community property law:
  • All property acquired during marriage is jointly owned
  • When one spouse dies, both halves receive a step-up in basis
  • This “double step-up” allows the surviving spouse to sell the entire asset with minimal or no gain

Compare this to non-community property states (like New York or Florida), where only the decedent’s share gets a step-up.

  1. Alternate Valuation Date (6 Months Post-Death)
    Executors of taxable estates can choose to value estate assets six months after the date of death if:
  • It lowers the total estate value, and
  • It results in less estate tax

This can impact the basis of inherited assets if the alternate valuation is elected. It must be applied consistently across qualifying assets.

  1. Trusts
    Whether trust assets receive a step-up depends on the type of trust and whether the assets are included in the decedent’s estate.
  • Revocable Living Trusts:
    • Owned by the decedent during life
    • Included in the taxable estate
    • Do receive a step-up in basis
  • Irrevocable Trusts:
    • May be excluded from the estate for estate tax purposes
    • May not receive a step-up, depending on how the trust was structured

For example, if assets were moved into an irrevocable grantor trust and excluded from the estate, those assets likely won’t qualify for step-up under Revenue Ruling 2023-2.

Understanding these nuances ensures your estate plan doesn’t unintentionally lose out on valuable tax benefits.

If you’re unsure whether your assets qualify, or how to fix a trust that doesn’t allow a step-up, we can help review your plan and provide options.

Many families face the question: should I gift my property to my kids now, or leave it to them when I die?

General rule: Don’t gift highly appreciated property unless there’s a compelling reason (e.g., asset protection, Medicaid planning).

A lifetime gift passes along your original basis. An inheritance gives your heir a new, higher basis.

Instead, consider:

  • Using a revocable trust to control the asset and avoid probate
  • Keeping full ownership to secure 100% step-up
  • Using trust-based planning to avoid risks of gifting (e.g. divorce, creditor exposure)

How We Help Clients Use This Strategy

At Echelon Financial, our CPAs and financial advisors use the step-up in basis as a core strategy in our estate planning framework.

We help clients:

  • Avoid premature gifting of low-basis assets
  • Structure ownership between spouses to maximize double step-up
  • Use revocable trusts to streamline transfers and preserve tax treatment
  • Reposition trust assets before death to bring them back into the estate for step-up
  • Evaluate upcoming legislation and plan proactively

If you’re unsure whether your current estate plan takes full advantage of this rule, we can help review it.

Wrapping Up

Here’s what we covered:

  • Step-up in basis resets your tax cost basis to the fair market value at death, eliminating tax on prior gains
  • It applies to capital assets (real estate, stocks, businesses), but not to IRAs or deferred income
  • It can save heirs tens or hundreds of thousands in capital gains taxes
  • There are rules, exceptions, and legislative risks you need to understand
  • With proper planning, you can preserve more wealth for the next generation

Don’t leave this to chance.

We’ve helped dozens of families across Austin and beyond optimize their estate plan around the step-up in basis. If you’d like us to do the same for you, schedule a strategy call today.