What is the step-up basis in estate planning?

The short answer

When an asset is inherited in the U.S., its cost basis is “stepped up” to the fair market value on the date of the decedent’s death. The deferred capital gains tax that would have been owed on the lifetime appreciation is permanently extinguished. This is one of the most powerful and least-discussed subsidies in the U.S. tax code.

The step-up combines with the federal estate exemption to create a strong incentive to hold appreciated assets until death rather than sell them during life or gift them. The OBBBA, signed July 4, 2025, set the federal estate and gift tax exemption at $15M per person ($30M for couples with portability) starting in 2026, with no sunset and inflation indexing thereafter.

Combined, these features mean that fewer than 0.1% of U.S. estates owe federal estate tax under the new regime, while step-up benefits flow to virtually all heirs of appreciated assets.

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What the data shows

The interaction of step-up basis and estate exemption has shifted dramatically since OBBBA.

The legislative context (OBBBA July 2025; pre-OBBBA TCJA expectations):

• OBBBA set the federal estate and gift exemption to $15M per person from January 1, 2026, indexed for inflation from 2027 — replacing the 2025 exemption of $13.99M and overriding the prior scheduled sunset to roughly $7M
• The step-up basis was preserved unchanged under OBBBA, despite being a recurrent target of reform proposals
• The federal estate tax rate above the exemption remains at 40%, unchanged since 2013
• The annual gift tax exclusion is $19,000 per recipient in 2025, indexed for inflation; the non-citizen-spouse annual exclusion rises to $194,000 in 2026

The exception that nuances the picture: state-level estate and inheritance taxes apply in roughly a dozen U.S. states with thresholds far below the federal level. For estates above these state thresholds, the step-up does not eliminate state-level tax even when federal liability is zero.

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Why it happens — the macro mechanism

The step-up basis interacts with the rest of the tax system through three reinforcing mechanisms.

Channel 1 — The buy-borrow-die optimisation. The combination of step-up at death plus borrowing against appreciated assets allows wealthy households to access capital without realising taxable gains. Loans against marketable securities are not income; the step-up at death erases the underlying gain. The strategy has been formalised in the literature as a near-frictionless way to consume from an appreciated portfolio.

Channel 2 — The OBBBA gift-or-hold flip. Before OBBBA, the scheduled 2026 sunset would have cut the exemption to roughly $7M, creating urgency to gift assets during life to lock in the higher exemption. OBBBA removed this urgency by making $15M permanent, restoring the relative attractiveness of holding appreciated assets until death to capture the step-up. The arithmetic shifted: for estates well below $15M, holding for the step-up dominates lifetime gifting, since gifting transfers original basis while holding resets it.

Channel 3 — The clientele effect on holding periods. The step-up subsidises long holding periods. Empirically, this contributes to the lock-in effect: investors with significant appreciated positions resist realising gains, expecting to bequeath the position. Auerbach and Siegel’s work on lock-in shows that elasticity of capital gains realisation to tax rates is highest near the rate threshold and lowest near death.

Synthesis by regime: in the pre-TCJA regime ($5M exemption), estate tax was a real concern for upper-middle-class families and gifting strategies dominated. In the TCJA regime ($10M-$13M, scheduled to sunset), planning was bifurcated between use-it-or-lose-it gifting and holding. In the OBBBA regime ($15M permanent), gifting is largely obsolete for non-billionaire households and step-up holding becomes the dominant default. The transition parameter is the relationship between the household’s total estate and the indexed federal exemption.

OBBBA quietly turned the step-up basis from one option among several into the default optimum for the vast majority of U.S. households.

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What it means for different economic actors

Middle-class and upper-middle-class households receive the largest practical benefit. Estates well under $15M owe no federal estate tax, and heirs receive a clean basis on appreciated stocks, real estate, and other assets — eliminating capital gains tax on decades of appreciation.

Ultra-high-net-worth families still face the 40% rate above $15M (or $30M for couples). For them, the planning conversation focuses on the marginal estate above the exemption, where lifetime gifting and trust structures retain their relevance.

Charities and beneficiaries of appreciated gifts face a parallel asymmetry: gifting an appreciated asset to charity during life avoids capital gains while creating a deduction; holding the same asset until death also avoids capital gains via step-up but loses the lifetime deduction.

A common error is to focus exclusively on estate-tax planning while ignoring the income-tax implications of basis treatment. Under OBBBA, income-tax planning around the step-up is more impactful than estate-tax planning for nearly all households.

Practical observation

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Frequently asked questions

Has OBBBA changed the step-up basis itself, or only the exemption around it?

Only the exemption. OBBBA preserved the step-up unchanged while making the higher estate exemption permanent at $15M from 2026, indexed for inflation. The combination amplifies the step-up’s practical importance: more estates avoid federal tax entirely, allowing the basis reset to flow through cleanly to heirs without offset by transfer-tax liability.

Why has gifting strategy become less attractive under OBBBA?

Lifetime gifts transfer the donor’s original cost basis to the recipient, who inherits the deferred gain. Assets held until death receive a stepped-up basis instead. Pre-OBBBA, the scheduled 2026 sunset to roughly $7M created urgency to use the exemption through gifts. With $15M now permanent, that urgency is gone for estates safely below the threshold, and holding for the step-up usually dominates gifting on income-tax grounds.

What about state estate or inheritance taxes?

Around a dozen U.S. states impose their own estate or inheritance taxes, often with thresholds far below the federal exemption. The step-up basis applies to federal income tax only and does not directly address state-level transfer taxes. For residents of these states, the planning calculus combines federal income-tax benefits with state-level transfer-tax considerations.

Last updated — 20 September 2026