The Step-Up

Estate Planning

Here's a rule that changes which accounts you should spend and which you should keep, and almost nobody outside estate law knows it exists.

When you die, the capital gains in your taxable brokerage account disappear.

Not deferred. Not passed to your heirs to pay later. Gone. Erased. Your heirs receive the assets with a brand new cost basis equal to their value on the day you died, as if they had just bought them at that price. Thirty years of embedded gains, and the tax bill on all of it, simply vanishes.

It's called the step-up in basis, and it's arguably the most powerful estate planning tool in the entire code, available for free, to everyone, with no paperwork.

What it looks like

A hypothetical widow (invented for illustration, not a real client) bought $80,000 of index funds in 1996 and never sold. Today they're worth $620,000. If she sold tomorrow, she'd owe capital gains tax on $540,000 of gain, roughly $100,000+ at federal rates.

Instead she holds them until she passes. Her daughter inherits the shares with a cost basis of $620,000. She can sell them the next day and owe zero. The $100,000+ tax bill was never paid by anyone.

Compare that to inheriting a Traditional IRA of the same size, where the daughter owes ordinary income tax on every dollar within ten years. Or a Roth, which is tax-free but couldn't get any BETTER. The taxable brokerage account went from the least tax-efficient account to hold in life to one of the best assets to leave at death.

The Texas double

Now the part that's specific to us. In most states, when one spouse dies, only that spouse's half of a jointly-owned account gets stepped up. The surviving spouse's half keeps its original basis.

Texas is a community property state. And in community property states, when the first spouse dies, BOTH halves of community property get the step-up. The full account. The surviving spouse can sell every share the next week and owe nothing on decades of gains, while still alive.

Take a hypothetical Texas couple with $1M in a joint brokerage account and $700,000 of embedded gain. In a common-law state, when he dies she gets a step-up on his half: $350,000 of gain wiped, $350,000 remains. In Texas, all $700,000 is wiped. That's roughly $50,000 to $80,000 of tax that a Texas couple avoids and a Colorado couple pays, for owning the same funds in the same account.

Two conditions: the assets have to actually be community property (generally, acquired during the marriage with marital funds, and not something inherited or gifted to one spouse), and they need to be titled and documented as such. Assets brought into the marriage, or an inheritance one spouse kept separate, may not qualify. Worth a conversation with an estate attorney to confirm what's what.

What it changes about spending

Once you understand the step-up, the withdrawal-order logic gets a new rule: the assets with the biggest embedded gains and the lowest odds of being spent in your lifetime should be spent LAST, or never.

Spending from Traditional IRAs during the Golden Window makes even more sense (that account is the worst to inherit anyway). Harvesting gains at low rates makes sense on shares you'll actually spend. But those 1996 index funds you're never going to touch? Leave them exactly alone. Every dollar of gain you don't realize in life is a dollar of tax nobody ever pays.

It also changes the giving math: appreciated stock is a great thing to donate while alive (the gain vanishes for charity), but if a share is destined for your kids anyway, the step-up erases the gain just as well. Give from the IRA, leave the brokerage to the kids, and let both tax bills disappear.

The catches

The step-up can go DOWN, too. Inherit shares that lost value and the basis steps down to the lower number. Sell losers in your lifetime; hold winners.

Retirement accounts (Traditional AND Roth) never get a step-up. Their basis rules are their own thing.

Assets given away before death don't get one either. Gift your daughter $200,000 of appreciated stock while you're alive and she inherits YOUR basis, embedded gains and all. Sometimes the right move is to give her cash now and let her inherit the stock later.

And the rule has been a political target for years. It survives every session, but "current law" is the operative phrase in all of this.

Your brokerage account spent your whole life as the tax-inefficient one. It gets the last word.