TLH and Step-Up Basis at Death

For investors with significant wealth and a long time horizon, tax-loss harvesting becomes even more powerful when combined with step-up basis: realize losses now to reduce today's taxes, then pass appreciated assets to heirs, who inherit them at a stepped-up basis with no tax due.

Key takeaways

• Step-up basis at death resets the cost basis of inherited securities to their fair market value on the date of death, eliminating all embedded gains from the owner's lifetime.
• Tax-loss harvesting creates a powerful synergy with step-up basis: realize losses now (reducing current income), then hold gains until death (avoiding tax entirely).
• The two strategies together can save 50%+ on lifetime capital gains tax for high-net-worth investors, particularly those expecting minimal taxable income in later life.
• Step-up basis is a permanent feature of current U.S. tax law, though it faces periodic political pressure (proposals for "step-up basis repeal" appear in many tax plans).
• Married couples filing jointly can double their step-up benefit through strategic estate planning (holding appreciated assets in the first-to-die spouse's name).

Understanding step-up basis

Here's how step-up basis works in practice. Suppose you bought 100 shares of Berkshire Hathaway (BRK.B) in 1992 at $3,000 per share, for a total cost basis of $300,000. By 2024, those shares are worth $400,000 each—a gain of $39.7 million.

If you sold those shares today, you'd owe capital gains tax on $39,700,000 of gain. At the federal rate (20% for long-term gains, plus 3.8% net investment income tax, plus likely state taxes), you'd owe roughly $10–$12 million in federal tax alone.

But if you hold those shares until you die in 2025, and you pass them to your heirs:

• Your cost basis was $300,000.
• Your heirs' cost basis becomes $400,000 (the fair market value on your date of death).
• The gain of $39,700,000 is completely erased.
• Your heirs can immediately sell the shares and pay zero capital gains tax.

This is step-up basis, and it's one of the largest tax benefits in the U.S. tax code. The IRS estimates that step-up basis costs the federal government roughly $50–60 billion in foregone revenue annually.

Why tax-loss harvesting amplifies this benefit

Most investors see step-up basis as passive—you hold appreciated assets and benefit when you die. But savvy investors combine step-up basis with active tax-loss harvesting to create a two-pronged strategy:

Phase 1: Realize losses now (via tax-loss harvesting)

• Sell positions with embedded losses to offset current income.
• Harvest $100,000 of losses every 2–3 years from volatile positions.
• Each $100,000 loss saves $24,000–$37,000 in federal taxes (depending on tax bracket).
• This drives down your current-year tax bill while you're earning high income (peak working years).

Phase 2: Hold gains until death (via step-up basis)

• After harvesting losses, reinvest in positions with high expected returns.
• Don't sell these positions. Instead, hold them for 10, 20, 30 years.
• Enjoy the full capital appreciation without any realized gains or year-to-year taxable distributions (if they're individual stocks, not dividend funds).
• When you die, your heirs inherit at stepped-up basis—the entire embedded gain evaporates.

A concrete scenario

Let's trace this through for a real investor:

Year 1 (Age 45, high earning years)

• Portfolio of $2 million includes a position in XYZ Company, cost basis $500K, current value $1,200K (gain of $700K).
• Market drops 20% in 2022-style correction. XYZ is now worth $960K.
• You harvest the loss: sell XYZ at $960K, realizing a $460K loss (wait, no—the original cost was $500K, so the loss is $460K is wrong; let me recalculate: cost $500K, sell at $960K = gain of $460K, that's not a loss).

Let me restart with a clearer example:

Year 1 (Age 45, high earning years)

• Portfolio of $2 million includes a position in XYZ Company, cost basis $1,200K, current value $800K (loss of $400K).
• Market has declined. You harvest the loss: sell XYZ at $800K, realizing a $400K loss.
• This loss offsets $400K of other income, saving $96,000–$148,000 in federal tax (24–37% bracket).
• You reinvest the $800K proceeds in a similar company, ABC, at cost basis $800K.

Years 2–40 (Accumulation phase)

• ABC appreciates from $800K to $8 million over 30 years (9% annual return).
• You never sell ABC. You hold it through market ups and downs.
• You never realize gains on ABC, so you never pay capital gains tax on the appreciation.
• Your tax bill each year is zero on this position (assuming it pays no dividends).

Year 40 (Age 85, you pass away)

• ABC is worth $8 million. Your cost basis in your will is $800K.
• Your heirs inherit ABC. Their cost basis is $8 million (stepped-up).
• Your heirs can sell immediately and pay zero capital gains tax on the $7.2 million gain that accrued during your lifetime.

Lifetime tax comparison:

• Without TLH + step-up: Sell XYZ and ABC together in year 20 at $4 million total. Realize $3.2 million gain. Pay $640K–$760K in capital gains tax (20% + 3.8% + state).
• With TLH + step-up: Harvest loss in year 1 ($96K–$148K tax savings). Hold gains until death. Heirs inherit at stepped-up basis. Pay $0 on $7.2 million gain.

Total tax savings: $640K–$900K+.

For ultra-high-net-worth investors with $50+ million portfolios, this difference compounds across dozens of positions, potentially saving tens of millions in lifetime taxes.

Why this strategy works for certain investors

TLH combined with step-up basis is most powerful for:

1. Long time horizons (20+ years). If you plan to hold appreciated assets until death, step-up basis is guaranteed. If you might sell in 10 years, the benefit is lower.
2. High peak income years (age 45–65). You want to harvest losses while you have income to offset.
3. Declining income in later life (retirement). If you plan to have low taxable income in your 70s and 80s, you're not fully using future loss carryforwards, so harvest earlier when tax savings are more valuable.
4. Estate planning mindset. If you view your portfolio as a legacy vehicle (passing wealth to children or charity), step-up basis aligns with your goals.

The strategy fails or works poorly for:

• Short time horizons (5–10 years). Step-up basis only helps if you hold until death.
• Steady income in retirement. If you'll have $200K of retirement income for 20 years, you can't fully use loss carryforwards anyway.
• Individuals without heirs. If you plan to spend everything in retirement or donate to charity, step-up basis has no value.

Political risk: Step-up basis repeal

There's a critical caveat: step-up basis is not guaranteed forever. Since 2021, multiple tax reform proposals have included "step-up basis repeal," which would:

• Require heirs to inherit at the decedent's cost basis (no step-up).
• Impose a capital gains tax as if the deceased had sold all appreciated assets on the day of death.

A full step-up repeal would fundamentally change the TLH + step-up strategy. If your heirs inherit at cost basis instead of fair market value, the entire tax-deferral benefit evaporates.

As of 2024, step-up basis remains law. But investors in their 40s–50s should be aware that long-term tax planning based on step-up basis carries political risk. Having a tax advisor monitor proposals is prudent.

Married couples: Strategic positioning

Married couples filing jointly can amplify the step-up benefit through strategic estate planning. Here's how:

Scenario: Married couple with $10 million in appreciated assets

Instead of holding appreciated assets jointly or in one spouse's sole name, position them as follows:

1. Appreciated assets in the name of the first spouse to die (let's say the older spouse).
2. That spouse's will directs the assets to the surviving spouse (or trust for the surviving spouse's benefit).
3. When the first spouse dies, those assets receive a full step-up to fair market value.
4. The surviving spouse inherits them at stepped-up basis and can hold them further.

If the surviving spouse lives another 10+ years, the couple has effectively "reset" the cost basis mid-lifetime, creating a second opportunity to harvest losses from the newly stepped-up position.

This strategy is most valuable in couples with large age gaps or significant health disparities, where the first-to-die spouse is predictable.

Interaction with the federal estate tax

One complexity: step-up basis is coupled with the federal estate tax. If your estate exceeds the federal exemption ($13.61 million per individual in 2024, $27.22 million for married couples), you'll owe estate tax.

However, the estate tax and step-up basis can actually complement each other in unexpected ways. The step-up basis reduces the income tax burden on heirs, which can offset part of the estate tax cost. Tax advisors sometimes use this trade-off deliberately: accept some estate tax (0–40%) to avoid much larger capital gains tax (20–37%) on heirs.

Practical implementation

If you're considering this strategy:

1. Document your cost basis carefully. When you die, your heirs will need to prove your cost basis in order to calculate the stepped-up basis and future gains. Work with a CPA to maintain meticulous records.

2. Coordinate with estate planning. Ensure your will or trust documents are structured to maximize step-up benefit. A poorly drafted will can inadvertently forfeit the benefit.

3. Monitor TLH candidates annually. Every 2–3 years, review your portfolio for loss-harvesting opportunities during volatile periods. A market decline (2020, 2022) is the ideal time to harvest.

4. Reinvest harvested losses strategically. After harvesting, reinvest in positions with high expected returns, suitable for a 20+ year hold.

5. Work with a tax advisor. This strategy requires coordination between investing, tax, and estate planning—three disciplines. A CPA or CFP with estate planning expertise is essential.

Decision tree: Is TLH + step-up basis right for you?

Next

We've explored how tax-loss harvesting synergizes with step-up basis for legacy-oriented investors. Next, we'll zoom in on a regional dimension: how state income taxes dramatically alter the economics of tax-loss harvesting, particularly in high-tax states like California, New York, and New Jersey.

Related concepts

• What is Tax-Loss Harvesting
• The Mechanics of Realising a Loss
• Substitute Funds for TLH