The federal gift and estate tax exemption remains at a historically high level ($15 million for 2026), meaning many families won’t be subject to these taxes. As a result, there’s increased focus on income tax planning, including the use of stepped-up basis rules to help heirs reduce capital gains tax and preserve family wealth.

Understanding capital gains

When assets such as securities are sold for more than their purchase price, the profits are generally treated as taxable capital gains. If the assets were held for more than one year, the gains qualify for a favorable long-term capital gains tax rate.

Long-term capital gains are generally taxed at favorable rates of 0%, 15% or 20%, depending on taxable income. Additionally, some higher-income taxpayers may owe the 3.8% net investment income tax on top of those rates.

Conversely, a short-term capital gain is taxed at ordinary income rates, up to 37%. Gains and losses are accounted for when you file your tax return, so gains may be offset wholly or partially by losses.

The amount of a taxable gain is equal to the difference between the basis of the asset and the sale price. For example, if you acquire stock for $15,000 and then sell it for $45,000, your taxable capital gain is $30,000.

These basic rules apply to capital assets owned by an individual and sold during his or her lifetime. But a different set of rules applies to inherited assets.

What’s stepped-up basis?

Under the stepped-up basis rules, inherited assets generally receive a new tax basis equal to their fair market value on the date of the owner’s death. This means beneficiaries typically pay capital gains tax only on appreciation that occurs after they inherit the assets, while gains that accrued during the deceased owner’s lifetime generally aren’t subject to income tax.

Assets affected by the stepped-up basis rules include securities, artwork, business interests, investment accounts, real estate and personal property. However, these rules don’t apply to retirement assets such as 401(k) plans or IRAs.

Consider a simple example: Mary purchases XYZ Corp. stock for $100,000 and holds it until her death 10 years later, when the shares are worth $500,000. She leaves the stock to her son, Todd. Under the stepped-up basis rules, Todd’s tax basis becomes $500,000 rather than Mary’s original $100,000 cost.

Two years later, Todd sells the stock for $700,000. Because his basis is $500,000, he recognizes a $200,000 gain. Assuming a 20% long-term capital gains tax rate applies, he would owe $40,000 in tax. Without the basis adjustment, his taxable gain would have been $600,000, resulting in a $120,000 tax bill at the same rate.

If an asset declines in value during the deceased owner’s lifetime, the adjusted basis of the individual who inherits it remains the value on the date of death. This could result in a taxable gain on a subsequent sale if the value rebounds after death, or a loss if it continues to decline.

Planning ahead

The stepped-up basis rules can play an important role in preserving family wealth by reducing the capital gains tax heirs may face when they inherit appreciated assets. Contact your estate planning advisor to discuss how the stepped-up basis rules and other estate planning strategies may fit into your overall financial plan.