There is a rule in the tax code that erases more capital-gains tax than any strategy a planner can sell, and it asks nothing of the family except patience. Hold an appreciated asset until passing, and the heirs receive it at its value on the day of passing. The gain that built up over a lifetime is never taxed as income. Not deferred, not reduced: gone.
It is called the step-up in basis, and most people who benefit from it never knew it was there. That is fine when it works. The trouble is that it fails just as quietly, through ordinary decisions made years earlier by people who meant well, and the cost is only discovered when the heirs sell.
What basis is, and why it matters
Basis is what you paid. When you sell, the tax falls on the difference between the price and the basis, not on the price. A share bought for $10 and sold for $100 is taxed on $90.
For most of a life that arithmetic is fixed. Hold the share for thirty years and the basis is still $10; the gain, and the tax waiting on it, only grows. At death the rule changes. For most assets that pass through an estate, the heir’s basis becomes the fair market value on the date of passing, so the gain the owner never realized simply stops existing for income-tax purposes. (Whether the estate owes estate tax is a separate question, and for most families the answer is no.)
The arithmetic
Illustrative round numbers, federal tax only. They show a method; they do not describe anyone, and none of it is advice.
A parent holds stock bought for $100,000 and now worth $1,000,000. The gain embedded in it is $900,000. There are three ordinary ways it leaves the parent’s hands.
Sold during life. The $900,000 gain is taxed. At the top federal rate on long-term gains plus the net investment income tax, 23.8% in all, the bill is $214,200. The family keeps $785,800.
Given away during life. A gift carries the giver’s basis with it. The child now owns a $1,000,000 position with a $100,000 basis, and the whole $900,000 gain travelled with the shares. Sell next year and the tax is due on all of it, at the child’s rates. That can be less than the parent’s rate, which is exactly why gifting appreciated stock is sometimes the right move. But the gain was not erased. It was handed down.
Held until death. The heir’s basis becomes $1,000,000. Sell the next month at $1,000,000 and there is no gain to tax. The family keeps the full $1,000,000.
Same stock, same family, same value. A $214,200 difference decided by nothing but timing and the form the transfer took.
Where the step-up is lost
None of these is exotic. Each is an ordinary decision that looked sensible when it was made.
Simplifying before the end. An aging parent sells the concentrated position to “clean things up” and leave cash instead. It feels responsible. It triggers the full tax on a gain that, held a little longer, would never have been taxed at all.
Gifting the wrong asset. A parent gives away the stock that has grown the most, because it is the most generous gift, and keeps the cash. The heirs later inherit the cash (no gain to erase) and already own the stock (gain intact). Reverse the two and the family’s tax changes by six figures.
The passing gift that comes back. A child gives appreciated stock to a passing parent, expecting to inherit it back at a stepped-up basis. The code anticipated this: if the parent dies within a year of the gift and the property passes back to the giver or the giver’s spouse, it keeps the old basis.
Assets in the wrong kind of trust. A revocable living trust is included in the estate, and its assets step up. An irrevocable trust designed to keep assets out of the estate generally does not; in 2023 the IRS confirmed that assets in an irrevocable grantor trust that are outside the estate get no step-up. Some of those trusts let the grantor swap assets in and out, which is how practitioners move low-basis assets back into the estate before death. The power has to be written into the trust, and someone has to use it.
How the house is titled. When a married couple in a community-property state owns an asset as community property, both halves step up at the first passing. In most other states, jointly held property steps up only the half that belonged to the spouse who passed.
Retirement accounts. A traditional IRA or 401(k) has no basis to step up at all. The heirs pay ordinary income tax as they withdraw. Families that plan to leave “the portfolio” to the children often discover that the portfolio was two very different things.
No records. A step-up is only as good as the date-of-passing valuation behind it, and a carryover basis is only as good as the purchase records behind it. Stock bought in 1994 through a broker that no longer exists, or a building whose improvements were never totaled, becomes a basis nobody can prove.
The twin nobody mentions
The rule cuts both ways. An asset worth less than its basis at passing steps down. The unrealized loss disappears with the owner, and the heirs cannot use it. A loss that could have offset gains, or three thousand dollars a year of income, is simply gone.
So the same arithmetic that says “hold the winners” says something less comfortable about the losers: they are worth selling while the owner is alive to use the loss.
How it shows up in the wealth picture
Here is why this is a measurement problem rather than a legal one.
A statement shows two positions, each worth $1,000,000. One was bought for $950,000; the other for $100,000. They look identical, and they are not. Sold today at 23.8%, one leaves $988,100 in hand, the other $785,800. Held to passing, they leave the same. Given away, the difference goes with them.
Which one to sell when the family needs cash, which one to give, which one to hold: every one of those decisions turns on a number the statement does not print. Family offices keep it on one page as a matter of routine, as a column beside the market value, usually headed “unrealized gain” or “embedded gain,” with the date each lot was acquired. Not because they are planning anyone’s passing, but because the decision of what to sell is made every year, and it is made badly without that column.
What the number is not
It is not a reason to hold something you would otherwise sell. A position that no longer belongs in the portfolio can cost more in concentration than it saves in tax.
It is not estate planning. The rules above are general, the exceptions are many, state law matters, and the right structure for a family is a conversation with its lawyer and accountant, with the numbers in hand.
And it is not morbid. It is the same arithmetic as every other decision about selling, with one date in it that the family would rather not think about.
The older maxim
“In this world nothing can be said to be certain, except death and taxes.” Benjamin Franklin wrote it in 1789, in a letter about the new Constitution, and the line has outlived the letter by two centuries.
The step-up is the one place in the code where the first certainty cancels part of the second. It is also the one place where the cancellation depends entirely on decisions made while nobody was thinking about either. Franklin’s pairing is a joke about the inevitable. The step-up is a reminder that what is left behind is not.
Nothing here is advice. It’s the arithmetic, explained plainly.
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