Maximizing the Step-Up in Basis

By: Randall A. Denha, J.D., LL.M.

The step-up in basis at death is one of the most effective estate planning tools for reducing tax exposure and preserving family wealth. It allows heirs to inherit assets at their fair market value (FMV) as of the decedent’s date of death (or an alternate valuation date six months later, if elected). This eliminates unrealized capital gains, often saving heirs substantial taxes when they sell inherited property. With the federal estate tax exemption set at $13.99 million per individual in 2025 and scheduled to rise to $15 million in 2026 (indexed for inflation), most families will avoid federal estate taxes. As a result, capital gains planning through the step-up in basis has become more important than estate tax planning for many.

In common law states such as Michigan and Florida, only the decedent’s share of jointly held property is stepped up (typically 50% for spouses). This contrasts with community property states, where the entire property receives a new basis. Understanding these distinctions and applying the rules asset by asset can make a significant difference in outcomes for heirs.

Marketable Securities

Publicly traded stocks, bonds, mutual funds, and exchange-traded funds all receive a step-up to FMV at death. Heirs can sell or rebalance these assets immediately without incurring capital gains tax on the appreciation that occurred before the date of death. For families holding highly appreciated securities, waiting until death rather than gifting during life is usually the more tax-efficient strategy, since gifts transfer the original low basis.

Real Estate

Primary residences, vacation homes, and investment properties qualify for a step-up in basis. For rental property, this is especially valuable because heirs not only eliminate prior appreciation but also restart depreciation deductions based on the stepped-up value. In common law states, only the decedent’s portion of jointly held property receives a step-up. For example, if a couple owns a $2 million home with a $500,000 basis, upon the first spouse’s death, their half would step up to $1 million, resulting in a new total basis of $1.25 million ($1 million for the deceased spouse’s stepped-up half plus $250,000 for the surviving spouse’s original basis in their half). Titling strategies, such as tenancy-in-common, can help clarify ownership portions and maximize the adjustment.

Closely Held Businesses

Family businesses, partnerships, and LLC interests also qualify for a step-up, which can minimize gain if the entity is later sold or partially redeemed. Appraisals are essential, as business interests often involve discounts for lack of marketability or minority ownership that can reduce the reported fair market value. Buy-sell agreements should be reviewed to ensure they don’t establish a price that could be binding for estate tax purposes under IRC Section 2703. For regions with strong small-business sectors, like manufacturing in Michigan or real estate in Florida, these considerations are particularly important.

Tangible Personal Property

Assets like art, jewelry, antiques, and collectibles also receive a step-up. This is significant because collectibles can be taxed at a higher capital gains rate (28% versus 20% for most assets). For wealthy retirees or families with high-value collections, obtaining professional appraisals at death ensures the stepped-up value is defensible and maximizes tax savings.

Life Insurance

Life insurance death benefits are income-tax free under IRC Section 101(a), so the step-up does not apply to the proceeds. However, if a policy has cash value, that amount is included in the estate at FMV and receives a basis adjustment. While less impactful than other categories, this remains a consideration in comprehensive planning.

Retirement Accounts

Unlike most assets, IRAs, 401(k)s, and similar retirement plans do not receive a step-up in basis. Beneficiaries must pay income tax on distributions, subject to the SECURE Act’s 10-year distribution rule for most non-spouse beneficiaries. Strategies to mitigate this burden include Roth conversions during life, charitable bequests of retirement assets, or spending down retirement accounts first to preserve step-up-eligible assets for heirs. Here, state income tax differences matter: Michigan imposes a state income tax on distributions, while Florida does not.

Advanced Planning Strategies

To capture the maximum benefit of the step-up, families should:

• Hold appreciated assets until death rather than gifting them during life, since gifts carry the donor’s basis.
• Use revocable living trusts, which keep assets in the grantor’s estate under IRC Section 2038 and preserve step-up treatment, while also avoiding probate (a particularly useful feature in Florida, where probate can be costly and public).
• Review older bypass or credit shelter trusts, which were valuable when exemptions were lower but can now trap low-basis assets. Modern planning often favors portability elections or, in some states, trust decanting to restore basis step-up opportunities.
• Leverage grantor trust swap powers under IRC Section 675(4)(C) to exchange low-basis assets back into the estate for high-basis ones before death, ensuring equivalent fair market value in the exchange.
• Ensure professional appraisals for real estate, business interests, and collectibles to substantiate fair market values and protect against IRS challenges.

Key Takeaways

The step-up in basis is often more valuable than estate tax planning for families under the exemption threshold. Most categories of assets qualify, but retirement accounts remain excluded. Titling, trust structure, and state-specific rules can all affect outcomes. In Michigan, state income tax makes step-up especially useful for taxable assets, while in Florida, the lack of income tax and higher probate costs highlight the role of revocable trusts. Families should periodically review their estate plans to ensure assets are positioned to maximize the step-up. With exemptions scheduled to change in 2026 and potential legislative changes on the horizon, proactive planning ensures wealth is preserved, heirs are protected, and taxes are minimized.