Hold Stock Until Death (Step-up in Basis)

Holding highly appreciated assets, like stock, until death allows your heirs to inherit the assets with a stepped-up cost basis equal to the fair market value (eliminating capital gains tax).

Strategy Overview

Current tax rules stipulate that when you die, all of your assets have the tax basis reset to the value when you passed away. For estate planning purposes, this creates a significant tax-saving opportunity if you own highly appreciated assets and do not need to sell those assets to support your lifestyle in retirement: you can intentionally not sell highly appreciated assets, avoiding the payment of capital gains tax by both you and your heirs.

Tax Details

More than a century ago, the US created tax rules regarding the step-up in basis for assets upon death. As of today, the rules stipulate that when you die, all of your assets have the tax basis reset to the value when you passed away (which means the tax basis is increased for assets with gains and decreased for assets with losses).

For individuals who are developing a strategic estate plan, understanding these rules and setting up their investment portfolios to best capitalize on this can have a large impact. Current long-term-capital-gains tax rates top out at 20% + 3.8% for NIIT + state income tax (if your state assesses this) -> which could potentially top 35% in some circumstances.

If your portfolio has a number of assets with significant capital gains, you have a large opportunity to optimize for tax by building the portfolio around the positions with the largest gains (i.e. the positions that, if sold, would be taxed the heaviest). And then when capital is needed from the portfolio, you would select and divest of assets with losses or minimal gains (and continue to hold the assets with the largest gains -> ideally until you pass away).

This strategic positioning and planning will allow your heirs to inherit a larger amount of assets (because the step-up obviates the need to pay LTCG on the gains).

Key Benefits

• Eliminates capital gains tax on appreciated assets. Achieving a step-up in basis upon death essentially eliminates the capital gains tax that would have otherwise applied if the appreciated asset were sold.

Key Considerations/Flags

• May require taking on concentration risk. Holding onto all your appreciated stock position(s) until death means not selling the appreciated assets. If this is a diversified ETF, this may be relatively easy to do. But if this is a single company stock, holding means you will need to accept the associated concentration risk.

• Estate tax may still apply. For ultra-high net worth households, estate tax may still apply. The step-up in basis does not affect estate tax, which is based on the overall value of your estate, not the cost basis of the assets. For more information see: Estate Tax

• Potential changes to tax laws. Tax laws are subject to change. In recent years, there has been discussion about changing the laws around the step-up in basis. It's important to stay informed about potential tax law changes and how they might impact your strategy.

Strategy: When to Consider This and When to Avoid It

🟢 When to Consider This Strategy:

• If you have highly appreciated assets that you likely won't need to sell prior to death. This strategy is only applicable if an individual does not need to sell the appreciated asset(s) for retirement cashflow purposes or prior to death.

🔴 When to Not Use This Strategy:

• If you anticipate needing to sell the appreciated asset prior to death. Most households save for retirement and then gradually sell assets during retirement to generate cash flow. If this describes your likely future/investment plan, this strategy is unlikely to apply.

• Holding the appreciated position makes you uncomfortable. Optimizing for investment portfolio needs and risk frequently supersede tax optimization. If holding an appreciated position would create an uncomfortable (or unacceptable) level of concentration risk, and/or materially misalign with your portfolio --> then holding the position to achieve a step up in basis is likely not a good idea.

🟡 Consider on a Case By Case Basis:

• If you anticipate that you will owe estate tax. The step-up in basis does not affect estate tax, which is based on the overall value of your estate, not the cost basis of the assets. If you anticipate that you will owe estate tax, a step-up in basis strategy may still apply, but it needs to be considered holistically along with the rest of the estate and the goals of the estate plan.

Example