A stepped-up cost basis resets an inherited asset’s tax basis to its value at the original owner’s death. This can reduce the capital gain recognized when heirs later sell it. section 9.3.2
Choosing which account to sell
Consider an older retiree with a terminal illness, a taxable account containing long-held assets with very low cost basis, and an IRA. If cash is needed, selling from the IRA may preserve the taxable assets for heirs, who can receive them with a stepped-up basis. This can conflict with the usual preference to deplete taxable accounts first. section 9.3.2
The adjustment changes several planning comparisons:
- Asset location models may favor holding high-return stocks in taxable accounts when the model incorporates a basis step-up at death. section 8.4
- Withdrawal sequencing should account for heirs’ potential tax benefit rather than automatically selling taxable assets before retirement accounts. section 9.3.2
- The benefit is especially relevant for assets held for a long time with a large gap between current value and original basis. section 9.3.2
For quantitative analysis, incorporate death and the basis reset as a change to the after-tax value calculation for the taxable account. The resulting asset-location choice can differ from one based only on taxes paid at the investment horizon. section 8.4
