Harnessing the Power of Step-Up in Basis

Step-up in basis is something that the average person only needs to deal with once or twice in their lifetime. If you’re not sure what this means or how it relates to retirement planning, don’t worry: we’ll explain in detail.

There are two main scenarios in step-up in basis you may want to focus on:

  1. You inherited property or stock.
  2. You own a highly appreciated asset and want tax efficiency on the future disposal of the asset

What is Basis?

Basis is a tax term that the IRS and tax professionals assume everyone understands, but many don’t. “Basis” is your original purchase price of an asset. Let’s say you purchased a stock for $100. Your basis is $100.

If you purchase a real estate property for $300,000, this initial purchase price is your basis. Real estate does have a few additional nuances to determining cost basis, but for simplicity, this example works.

Cost basis is required when determining the gain or loss of a stock or other security; the difference between the sale price of an asset and the basis, or purchase price, of an asset is your gain.

Understanding your basis is crucial when talking about a “step-up.”

What is Step-up?

Let’s say that you purchased a property for $100,000 and have owned it for quite some time. Then in today’s market, you sell the property for $500,000. The difference between the purchase price and sale price means that you have a $400,000 gain.

If, instead of selling that same property, you decide to gift the property to your child (or anyone else), your child’s basis will be the same $100,000 basis that you had before you gifted the property. If your child decides to sell that property, they will have to pay taxes on the property’s appreciation in value beyond the $100,000 basis.

If you keep the property rather than selling or gifting it during your lifetime, and then your child inherits that property after you pass away, that is when a step-up in basis occurs. Instead of your original $100,000 basis carrying over to your child, their basis in the property will now “step-up” to the current market value of the property at the time of your death. Thus, if the value of the property at the time of your death is $400,000, your child (or whoever inherits the property) will have a basis of $400,000.

This difference matters. In the scenario where your child receives the property as a gift and later sells it for, let’s say $425,000, they will owe tax on the difference between their $100,000 basis and the $425,000 sale price which is a $325,000 gain. In a scenario where your child inherits the property and later sells it for $425,000, they could owe tax on the difference between their stepped-up basis of $400,0000 and the $425,000 sale price which is a $25,000 gain. The table below shows a side-by-side comparison of the example numbers in these scenarios.

Gifted Property Inherited Property
Basis $100,000 $400,000
Market Value at Sale $425,000 $425,000
Taxable Gain $325,000 $25,000


The more the property appreciates in value beyond the time of a gift or inheritance, the higher the potential taxable gain will be. But an inherited property with a stepped-up basis is more favorable as it will likely reduce what the potential taxable gain could be compared to a gifted property with a carryover, or transferred, basis.

Put simply, a step-up in basis helps relieve inheritors of what could otherwise be massive capital gains taxes.

Example of Step-up in Basis and Stock

Many people hold Tesla, Apple, NVIDIA, and other stock as part of their portfolio. For this example, you purchased $100,000 worth of stock many years ago, and today it’s worth $500,000. You might be receiving dividends, and this may be all you really need in terms of income from the stock.

If you were to sell all the stock today at a $400,000 gain, this would trigger substantial capital gains tax. Another option aside from selling could be to hold onto that stock with the plan to pass it onto your beneficiaries as their inheritance. With this intention, you do need to have faith in the company for it to at least maintain its stock value or ideally continue to increase in value; be aware of the risk that the stock’s value may decline by the time your beneficiary does inherit it.

Let’s say you choose the second option to continue holding the stock, and by the time your heirs receive the stock, it is worth $1 million. By doing so, you avoid the capital gains tax that you would have paid if you liquidated the stock during your lifetime. And your heirs inherit the stock with a stepped-up basis of $1 million.

Your heirs could sell the $1 million in stock at the time they inherit it without a capital gains tax.  If they hold the stock in their own portfolio, they will not owe tax until the stock appreciates above their $1 million basis.

Dividend Reinvesting

Dividend reinvestment is one strategy that we see a lot of people engage in. What this means is that if you buy a dividend-paying stock, each dividend you receive will purchase more of that same stock. Each dividend purchase creates basis in that stock.

To correctly calculate the gain at the time the stock is liquidated (sold), you need to know the basis on each of these buys. Currently, most custodians do keep a record of basis for you that can be viewed on most statements or online in your account. As long as the custodian has a record of the basis, it will also be reported on the tax form generated for that account.

In contrast, when your children or someone else inherits the stock from you, your basis is no longer relevant because the inheritor’s basis will be the stock’s value at the time it is received.

How to Determine Basis at Inheritance

The IRS is easy to work with when dealing with step-up in basis. Your basis is the value of the inherited asset on the day of death. For stock or other securities, you can use historical values and all the data that is available on stock price value for a given day.

Real estate will need to be appraised for value at the time of death.

Should You Hold Something for Step-up in Basis or Diversify Because of Risk?

You may or may not want to hold an asset for the purpose of step-up in basis. Perhaps you need the money and want to sell the investment. You may also see that the investment’s value is likely to decrease soon, so you decide selling while the price is high is optimal.

Ideally, you should speak to financial professionals to understand the risks and benefits of selling versus holding.

You may have a $1 million portfolio and the stock in question is worth 10% of your total portfolio. If the stock has a good run and now accounts for 20% or 30% of your total portfolio value, you’re increasing your concentration risk by continuing to hold it. A significant decline in the value of that particular stock can negatively impact a substantial part of your portfolio, so it’s something to think through.

Diversifying by selling some or all that concentrated stock will likely require you to pay taxes, but it may be a better option long-term because it allows you to safeguard your total portfolio by spreading your dollars out. Speaking to your financial professional(s) on this topic can help with your decision, because your situation is unique, and you may not want to carry such a high risk.

If you want to talk to us and have us evaluate your situation, we’re more than happy to schedule a call with you.

Click here to schedule a call with us to discuss your step-up in basis situation.

Why Review Beneficiary Designations Annually

Retirement planning is a long process. When you first start trying to secure your retirement, your life may be entirely different than it is today. One topic that we’re passionate about is the need to review beneficiary designations annually.

Backtracking a little bit, we decided to discuss this topic in-depth with you after reading an article on MarketWatch.

The story begins with a man who has a market account worth around $80,000. Suddenly, this man passes away, and the beneficiary of his account is his prior wife. However, his prior wife was deceased.

What Happens if the Beneficiary of an Account is Deceased?

In the scenario above, the man’s prior wife is deceased already. When he passes on, the account then goes to his estate. His account must then go through probate and into the estate, too.

However, in this man’s case, he had a daughter who was meant to inherit the account. Her stepmother even sent the daughter a text message stating that her father wanted her to have the money in the account.

Fast forward a bit, the stepmother becomes the executor of the estate after the account goes through probate and says, “She thinks the girl’s father changed his mind and that the money is meant to go to her, the stepmother.”

The daughter feels like the stepmother betrayed her father.

Unfortunately, a text message isn’t enough legal grounds for the daughter to fight back against her stepmom.

This is an example of someone who didn’t review beneficiary designations annually. Instead of the father’s wishes being upheld, someone else decided what they thought was best for the funds in the account.

Key Takeaways from this Example

Beneficiary designations are very important. We don’t know what the father wanted to happen to the funds in his account, nor do we know what may have been written in his estate plan. What we do know is that the daughter does have a message from her stepmother stating that the funds were meant for her, but something changed along the way.

We can speculate that perhaps the stepmom found estate documents mentioning that she received the estate, or maybe she fell on hard times financially and wanted to keep the funds.

In all cases, this could have been avoided by:

  • Reviewing beneficiaries annually
  • Updating beneficiaries when major life changes occur

Many accounts that you have often allow you to add beneficiaries, even if you don’t know that you can. For example, you can add beneficiaries to IRA, 401(k) and life insurance. You can even add beneficiaries to checking accounts.

We recommend that you:

  • Gather all of the accounts that have money in them
  • Inquire with all of these accounts if you can add a beneficiary

Probate and state law can vary from state to state dramatically. The daughter in the case above wanted to know if she could use the text message as evidence and file a lawsuit.

Contesting Probate 101

We don’t know the logistics of the case the daughter has or if a text message will mean anything in her scenario. Likely, the text will not hold up in court. What we are certain of is that contesting probate is:

  1. Lengthy and can be very difficult to do
  2. Costly

Avoiding any probate contestation is always in your best interest. The father in the example above may have been able to add a contingent beneficiary to his account. What this does is say, “If the first person is no longer living, the next beneficiary should be this person.”

Contingent designations would have helped this family avoid probate court and animosity between the daughter and stepmom.

7 Steps to Manage Your Beneficiaries Throughout Your Life

1. Review Your Beneficiaries Annually

For our clients, we do a beneficiary review each year. We show them who is listed on their accounts as a beneficiary, including:

  • Beneficiary name
  • Percentage to each beneficiary
  • Contingents
  • Etc.

If you’re not a client of ours, you can easily do this review on your own. Reach out to all of your account holders and ask them who you have listed on your account as a beneficiary. It is possible that you sent in a form to change a beneficiary and it was never filed.

It’s so important to verify your beneficiaries annually, even if you have a form sitting in front of you naming the beneficiary, because you just want that peace of mind that everything has been filed properly.

2. Consider Tax Implications

When you leave accounts behind, they may have certain tax implications that you need to worry about. For example, an IRA is taxed one way and a Roth IRA is taxed another way. It’s important to know the implication of each account to make it easier to understand who best to leave the account to when you pass.

If you leave an account to a high-income earner, they may take the money out of the account and pay the tax burden. Then, they may decide to give the money to your grandkids.

However, there are ways that you can set up these accounts to avoid this high tax burden and leave the funds to your grandkids directly. You can do what is known as “disclaiming,” which would allow your son or daughter to divide the money how they see fit with fewer potential taxes.

3. Understand the Impact on Your Overall Estate Plan

Let’s assume that you’re leaving $1 million behind with most of it in an IRA or 401(k) and have beneficiaries attached to it. The remaining part will go through the estate plan. In this case, you may be disinheriting a child if:

  • In one area, you split the funds 50/50
  • Another area you split the funds 80/20

When going through a beneficiary review, it’s important to look at the dollar amounts that are given to each child. You may decide to leave $500,000 to one child and $1 million to another child.

In this scenario, one child would need to receive the house and an additional $250,000 and the other $750,000 to split the inheritance evenly. Of course, you can divide your estate up however you see fit, even if that means one child receives far less than the other.

4. Consider Beneficiary Needs

Beneficiaries may have different needs. If one beneficiary is a high-income earner and the other is not, the high-income earner may not need as much money. You may even want to allow the high-income earner to disclaim the inheritance to give to their kids without the high tax burden.

If you have a special needs child, you also need to consider how the inheritance may impact their benefits. In this case, you may want to consider a trust account so that the child still receives their benefits and the help they need.

Another common scenario is that:

  • Your child is not good with money
  • The child may spend all of their money at once

In this case, a trust and a discussion with an attorney can empower you to leave money behind and dictate how it is used with greater control.

5. Be Specific 

For example, your intent is to leave 25% of the money to your grandchildren. It’s better to name the grandkids as primary beneficiaries. The reason for this is that people may forget how you want the money divided, and being very specific in your documentation can help clear any potential confusion.

6. Consult with an Attorney

An attorney is a second set of eyes who will look through all of your beneficiaries and estate plans with you. We know quite a few attorneys who are highly skilled and still hire others to review their documents with them in case they overlook something.

If you need a trust, the attorney can also assist with that.

Legally drafted documents will hold up far better in court than you writing a will on a piece of paper.

7. Consider Contingencies

In our story of the daughter and stepmother above, a contingent would have been immensely helpful. The reason why adding a contingent is so important is that if, for some reason, you get sick and do not check your beneficiaries, you already have a contingency in place.

The father could have listed the mom as the primary and the daughter as a contingent, which would have helped those he left behind avoid arguments and disagreements along the way.

What if the father set the contingent so long ago that both the primary and contingent are no longer living at the time of his death?

He could have left the funds to his grandkids if the institution allowed him to mention “per stirpes,” which means if the primary is not alive, the funds will go down the line to the person’s descendants equally.

Per stirpes is a powerful designation because you don’t even need to know the names of the person(s) to whom you’re leaving the funds. 

Annual beneficiary reviews and putting contingencies in place are powerful tools that we firmly believe are worth using. You can help your family avoid grief and any potential arguments if you spend the time going through your accounts and putting all these measures in place.

Are you curious about retirement and want to gain more insight into the process? Click here to browse through books we’ve authored on the topic.

April 10, 2023 Weekly Update

We do love it when someone refers a family member or friend to us.  Sometimes the question is, “How can we introduce them to you?”   Well, there are multiple ways but a very easy way is to simply forward them a link to this webpage.

Here are this week’s items:

Portfolio Update:  Murs and I have recorded our portfolio update for April 10, 2023

This Week’s Podcast -Why Review Beneficiary Designations Annually?

Listen in to learn the importance of naming contingent beneficiaries after your primary beneficiaries to ensure everything is clear. You will also learn why you need to consider the tax implications of each account, the needs of your beneficiaries, and its impact on your overall estate plan.


This Week’s Blog – Why Review Beneficiary Designations Annually?

Retirement planning is a long process. When you first start trying to secure your retirement, your life may be entirely different than it is today. One topic that we’re passionate about is the need to review beneficiary designations annually.