Instead of trying to time the market, clients can invest for the long-run and build tax-free wealth by utilizing step-up in basis
The $315,000 Tax Bill That Never Had to Be Paid After decades of holding appreciated stock, one long-term investor discovered that with the right estate planning structure that incorporated step-up in basis, his heirs could inherit those assets without paying a dollar in capital gains tax — preserving over $315,000 in wealth for his family.
Background: How Can Long-Term Investors Turn Unrealized Gains into Tax-Free Wealth?
Most people try and “time” the market and constantly buy in and out of their investments. What they don’t realize is that this approach often costs them more than it earns them for two primary reasons:
- Very few people can time the market: Only a small amount of hedge funds beat the market on a consistent basis. In fact, from 2010 through 2025, the market (12.86%) has more than doubled the average annual hedge fund returns (6.22%). So trying to buy in and out of the market is a losing affair for even the most qualified of professionals. The chance of the average person doing it is a fraction of the percentages listed above. Nevertheless, people are intent to keep on trying to do that feeling that they have a better grasp of the market than those who live and breathe it on an ongoing basis.
- If you invest in the market for the long run, a good 80%-90% of your returns will be tax-free: Even if you’re that 1 in a 100 individual who can actively beat the market, if you do then all of your gains will be taxed—at rates as high as 30%-50% of your gains. So what’s the point of trying to beat the market when you’ll lose 30%-50% of your return anyways? Especially since if you are a long-term investor you and your family can invest almost entirely tax-free through a provision of the tax-code known as “step-up in basis”.
What is Step-Up in Basis?
When people sell an asset—be it a stock, a business, a home, etc—they are taxed on the difference between what they purchased that asset at (known as their “basis” in the asset) and the value that they sold it at. Let’s look at a quick example. Let’s say you bought a share of the S&P500 for $1 and it’s now worth $1 million. If you sell it, the federal government (and in most cases your state of residence) taxes you on the gain between the sales value ($1 million) and the price you purchased it at ($1). The price you purchased it at is known as the stock’s “cost basis”. That’s a $999,999 gain ($1M -1 = $999,999) If the client lives in California—a state with a high tax-rate—and is already making $200,000 from his W2 job. Due to his high tax-rate, the client is losing $315,000 of that to taxes.
The Effect of Taxation on Selling an Asset with Low Basis
| A | B | C=A-B | D | E = D*-C | F = A + B |
| Current Market Value | Basis | Taxable Gain | Effective Federal and State Tax Rate | Tax Owed | Net After-Tax Income |
| $1,000,000 | $1 | $999,999 | 31.5% | ($315,000) | $685,000 |
Selling an asset means paying taxes on the difference between the market value and the basis
Selling an asset in January just to buy that same asset back a couple months later to try and “time” the market introduces significant tax-drag that doesn’t happen if you just hold the asset for the long-term.
Let’s say instead of selling the asset you held the asset until you die. After you die, your beneficiary inherits it and when they do the basis gets stepped-up from $1 to the current market value. What this means is that the taxable gain is no longer $999,999. It’s $0 ($1M - $1M = $0)
This way when your kids sell the asset, they don’t pay any taxes on the gain
The Effect of Taxation on Selling an Asset with “Stepped-Up” Basis
| A | B | C=A-B | D | E = D*-C | F = A + B |
| Current Market Value | Basis | Taxable Gain | Effective Federal and State Tax Rate | Tax Owed | Net After-Tax Income |
| $1,000,000 | $1,000,000 | $0 | 31.5% | ($0) | $1,000,000 |
When the basis of an asset gets “stepped-up” it allows the beneficiaries of the client to sell the asset-tax free.
In the table above, we can see that when the basis is stepped-up to the current market value that there is no taxable gain. This allows the beneficiary to sell the asset and not pay any taxes on the increase in value of the asset. How Can We Use Step-Up in Basis to Build Tax-Free Wealth?
Armed with this information about step-up in basis, how can we use this information to build tax-free wealth? The first is to understand by not trying to time the market and investing in assets for the long-run you can both improve your returns and build tax-free wealth. Constantly selling into and out of assets hurts both pre-tax and after-tax returns. The second is to understand that in community property states like California, it makes sense to hold onto long-term assets until at least the first spouse passes away. That way the surviving spouse can sell the assets without paying any taxes on the gains. Understanding the importance of separating short-term assets from long-term assets creates more long-term wealth for your whole family. How Can I Access Tax-Free Wealth During My Lifetime? While investing for the long-term helps build long-term tax-free wealth, you might be wondering how you can access this wealth tax-free during your lifetime. And the answer to that is by borrowing against your wealth, tax-free. And we cover the importance of doing that in our article, “Borrowing Against Your Portfolio”.
Is Using Step-Up in Basis a Tax-Strategy For You?
This strategy tends to matter most for:
- Long-term investors
- Business owners with highly appreciated assets
- Investors with large taxable brokerage accounts
- Families focused on legacy planning
- Retirees who don't need immediate liquidity
- Anyone trying to maximize what reaches the next generation
Understanding step-up in basis rules is one of the highest-leverage, lowest-effort planning moves available to families building lasting wealth.
Explore Your Strategy
Speak directly with Rajiv Rebello to see how this strategy fits into your comprehensive tax plan.