Capital Gains and the Step-Up in Basis
The single most valuable income tax rule in estate planning is one most people have never heard of. When you die owning an appreciated asset, your heirs receive it with a new income tax basis equal to its value at your death. The gain that built up over your lifetime is never taxed. A stock bought for $50,000 and worth $500,000 at death can be sold by your children the next day for $500,000 with no capital gains tax at all.
That rule, the step-up in basis, changes the calculus of almost every planning decision: whether to give an asset away or keep it, which assets to put in which trust, whether to sell a home or hold it, and how a Medicaid trust or an estate tax trust should be drafted. Getting it wrong means paying a tax that a different choice would have erased.
Milvidskiy Law Group P.C. builds basis planning into every estate plan we prepare and reviews existing plans, especially older trusts, to find where a step-up has been given away without reason.
Key Takeaways:
- Assets included in your estate at death generally receive a new basis equal to their date-of-death value. Assets you give away during life keep your original basis, and the recipient pays tax on your gain when they sell.
- Not everything steps up. Retirement accounts, annuities, and assets held in most irrevocable trusts do not, and some trusts can be drafted to preserve the step-up while still achieving their other goals.
- For estates below the federal and state estate tax thresholds, preserving the step-up is usually worth more than any estate tax technique, which is why gifting appreciated property is often a mistake.
Basis, Gain, and the Rule at Death
Your basis in an asset is, roughly, what you paid for it, adjusted for improvements and depreciation. When you sell, the difference between the sale price and your basis is your capital gain, and it is taxed. If you hold the asset until death, federal law resets the basis to fair market value on the date of death for property included in your estate. Heirs who sell at that value owe nothing. Heirs who hold and sell later owe tax only on the appreciation after your death.
The rule works in both directions. An asset that has declined in value is stepped down, and the loss disappears. That is why we sometimes advise selling loss assets during life to capture the loss, while holding gain assets to capture the step-up.
Lifetime Gifts Carry Your Basis
When you give an appreciated asset away during life, the recipient takes your basis. Suppose a parent gives a child a rental property bought decades ago for $150,000 and now worth $900,000. The child’s basis is $150,000; when the child sells, the tax is on $750,000 of gain. Had the parent held the property until death, the child’s basis would have been $900,000 and the gain would have vanished. The figures are illustrative, but the pattern is the most common and costly mistake we see in do-it-yourself planning: transferring the house or the brokerage account to the children to “avoid probate” and, in the process, handing them a tax bill.
The estate tax used to justify lifetime gifts for many families. It no longer does for most. The federal estate tax exemption is $15,000,000 per person for 2026, according to the Internal Revenue Service, and is indexed for inflation. New Jersey has no estate tax. For a family well under the federal threshold in New Jersey, giving away appreciated property during life saves no estate tax and forfeits the step-up. The analysis differs in New York, where the estate tax exclusion is $7,350,000 for 2026 with a cliff that can tax the whole estate above it, and in Connecticut, which has an estate and gift tax with an exemption equal to the federal amount. There, the estate tax saved by a gift may exceed the capital gains tax deferred, and the comparison has to be run with real numbers.
What Does Not Step Up
- Retirement accounts. Traditional IRAs, 401(k)s, and similar accounts are income in respect of a decedent. Beneficiaries pay ordinary income tax on withdrawals; there is no step-up.
- Annuities and deferred compensation. The untaxed growth is taxed to the beneficiary as received.
- Assets given away during life. Including assets placed in most irrevocable trusts, unless the trust is drafted so that the assets remain includible in your estate.
- Assets in a completed-gift trust. A dynasty trust, a SLAT, or a trust funded by a GRAT or a sale to a grantor trust holds assets at your basis. Those techniques trade the step-up for estate tax savings, and a swap power lets you pull low-basis assets back before death.
- Half of jointly owned property. Property held jointly with a non-spouse generally steps up only as to the decedent’s share, and the rules for spouses depend on how title is held. Community property, which New York, New Jersey, and Connecticut do not have, receives a full step-up on the first death.
How Planning Tools Interact With Basis
Medicaid asset protection trusts
A Medicaid asset protection trust is irrevocable, but it is usually drafted so that the assets remain in your taxable estate for income tax purposes, through a retained income interest or a limited power over the remainder. The result is a trust that protects the home from long-term care costs and still delivers a full step-up to the children at your death. A Medicaid trust drafted without that feature costs the family the step-up for no reason.
Grantor trusts and the swap power
Estate tax trusts that hold low-basis assets can be drafted as grantor trusts with a power to substitute assets. Before death, you exchange cash or high-basis assets for the trust’s low-basis assets. The low-basis assets return to your estate and step up; the trust keeps the value. Our irrevocable trusts page explains the mechanics.
Choosing what to give
When gifts do make sense, give high-basis assets and cash, and keep low-basis assets for the step-up. Give assets you expect to appreciate rather than those that already have. Consider whether an older relative with a smaller estate could hold an asset so that it steps up at that person’s death, an approach that requires care and is not for every family.
The home
A primary residence has its own exclusion from gain on sale during life, but it is capped and does not help heirs. Holding the home until death, or holding it in a trust that preserves inclusion, usually produces a better result than deeding it to children. A qualified personal residence trust deliberately gives up the step-up in exchange for estate tax savings, which is why it fits only taxable estates.
Real estate investors
Depreciated rental property carries a low adjusted basis and depreciation recapture. Holding until death eliminates both. A like-kind exchange defers gain during life and, if the replacement property is held until death, the deferred gain is eliminated as well. See our real estate page.
New York, New Jersey, and Connecticut
The step-up is a federal rule, and the three states follow it for their own income taxes. Where the states differ is in the estate tax that sits on the other side of the scale. New Jersey’s repeal of its estate tax for deaths on or after January 1, 2018 means that, for New Jersey residents under the federal threshold, holding appreciated assets until death is almost always the right income tax answer; New Jersey’s inheritance tax, which depends on who inherits, is a separate question. New York’s lower exclusion and cliff, and Connecticut’s estate and gift tax, mean that some residents of those states face a genuine trade-off between estate tax and capital gains tax, and the comparison drives the plan.
When Step-Up Planning Is the Wrong Priority
Preserving basis is not the goal when an asset must be sold during life to pay for care or to diversify a concentrated position, when the asset is likely to decline, or when the estate tax saved by a transfer clearly exceeds the capital gains tax deferred. Nor should the step-up override a beneficiary’s need for creditor protection or professional management, which an outright inheritance does not provide. The step-up is one factor in the plan, and we weigh it against the others rather than treating it as the only one. Our tax planning page sets out the alternatives.
What Our Service Includes
- A basis inventory prepared with your CPA: what each asset cost, what it is worth, and what the tax would be on a sale today.
- A comparison, for any proposed gift or trust, of the estate tax saved against the step-up forfeited.
- Drafting trusts that preserve inclusion where that is the right result, and swap powers where it is not.
- Reviewing existing trusts and deeds, particularly transfers made years ago, to identify where a step-up has been lost and whether it can be recovered.
- Integration with your estate plan, including the choice of assets to leave to individuals, to trusts, and to charity.
Schedule a Basis Planning Consultation
If you are considering giving property to your children, funding a trust, or selling a long-held asset, the basis question belongs at the front of the conversation. Our attorneys practice in New York, New Jersey, and Connecticut. Contact Milvidskiy Law Group P.C. to schedule a consultation.
This page is provided for general informational purposes only and does not constitute legal advice. Laws differ by state and change over time. Tax figures are as of the date stated and change annually. For advice about your situation, consult a qualified attorney.
Frequently Asked Questions
What is a step-up in basis?
When you die owning an asset that is included in your estate, your heirs receive it with an income tax basis equal to its fair market value on the date of your death. The capital gain that accumulated during your lifetime is never taxed. If your heirs sell at that value, they owe no capital gains tax; if they hold and sell later, they owe tax only on appreciation after your death.
Do gifts made during life get a step-up in basis?
No. A gift carries your basis to the recipient. If you give a child stock you bought for $50,000 that is now worth $500,000, the child’s basis is $50,000 and the gain is taxed when the child sells. Had you held the stock until death, the child’s basis would have been $500,000. This is why giving appreciated property away is often a costly mistake for estates below the estate tax thresholds.
Do assets in a trust get a step-up in basis?
It depends on the trust. Assets in a revocable living trust are treated as yours and step up at your death. Assets in an irrevocable trust step up only if the trust is drafted so that the assets remain included in your estate, as a properly drafted Medicaid asset protection trust usually is. Assets in completed-gift trusts such as dynasty trusts or SLATs keep your basis unless swapped out before death.
Does my IRA or 401(k) get a step-up in basis?
No. Retirement accounts are income in respect of a decedent. Your beneficiaries pay ordinary income tax as they withdraw the funds, and there is no basis adjustment at death. Annuities and deferred compensation are treated the same way.
Does a Medicaid asset protection trust preserve the step-up?
A properly drafted one does. The trust is irrevocable and protects the assets from long-term care costs after the look-back period, but it is designed so that the assets remain in your taxable estate for income tax purposes through a retained income interest or a limited power over the remainder. Your children receive a full step-up at your death. A Medicaid trust without that feature forfeits it.
What is a swap power and how does it help with basis?
A swap power lets the creator of a grantor trust exchange assets with the trust at equal value. Before death, you can substitute cash or high-basis assets for the trust’s low-basis assets. The low-basis assets return to your estate and receive a step-up; the trust keeps the same value. It is a standard feature of estate tax trusts that hold appreciated property.
Is it better to hold my house until death or give it to my children now?
For most families below the estate tax thresholds, holding the home until death, or placing it in a trust that preserves estate inclusion, produces a better result than deeding it to children, because the children receive a full step-up and can sell without capital gains tax. Deeding the house outright carries your low basis to them and can also create Medicaid and creditor problems.
How does jointly owned property step up?
Generally only the decedent’s share steps up. For property held jointly with a non-spouse, the portion the decedent contributed is included in the estate and receives a new basis while the survivor’s share keeps its original basis. Rules for married couples depend on how title is held. New York, New Jersey, and Connecticut are not community property states, so the full step-up available to community property does not apply.
Does the step-up apply in New York, New Jersey, and Connecticut?
Yes. The step-up is a federal income tax rule, and all three states follow it for their own income taxes. What differs is the estate tax on the other side of the analysis: New Jersey has none, while New York and Connecticut impose estate taxes that can make a lifetime gift worthwhile despite the lost step-up. The comparison depends on the size of the estate and the state of residence.
When does giving away appreciated property make sense despite losing the step-up?
When the estate tax saved clearly exceeds the capital gains tax deferred, which typically applies to estates above the New York, Connecticut, or federal thresholds; when the asset is expected to appreciate substantially so that future growth is what is being transferred; or when protection from creditors or long-term care costs is the priority. Even then, techniques such as swap powers and inclusion drafting can often recover the step-up.
