By Rick Waechter, Founder

One of the most favorable provisions for investors in the tax code is the step-up at death. It allows your heirs to reset the cost basis of your investments to the value on the date you die. Even if you have made an investment decades ago which, when you die, is likely to be worth multiples of what you paid, your heirs can sell it after your death and owe no capital gains tax.

It’s a remarkable windfall: the opportunity to wipe away taxes on decades of gain. But too often, people don’t take full advantage of it. Here’s what you need to know to maximize the benefit for your survivors.

1. Investments in your retirement accounts get no step-up at death. If you have a choice, put the investments you think have the highest likelihood for long-term appreciation into your taxable brokerage account, not in your IRA or 401k. Often, your retirement accounts are a better place to own bonds.
2. There’s no step-up if you give away an investment before you die. When, during your lifetime, you give your kids or grandkids 100 shares of a mutual fund you’ve owned forever, you also give them the cost basis – meaning you give them the future tax bill. That also applies if you gift shares to an irrevocable trust to move them out of your estate.
3. Be realistic about whether you will really hold an asset until you die. If you have a rental property, it’s unlikely you’ll want to keep that until you die, especially if it means dealing with landlord hassles in your 80s and 90s. If you’ll probably sell an investment before you die, think carefully about when to sell it, considering expected future taxable income. Sooner may be better than later. Just kicking the can down the road isn’t productive.
4. The most likely investments you will own until you die are the most diversified. The chance you will own an individual stock or real estate property until you pass away is lower than owning a diversified collection like a mutual fund or real estate limited partnership. It usually does not make sense to hold one stock for decades, because the company’s fortunes may change radically over time. Think about this before you buy a narrow investment.
5. If you own a large, individual investment with a significant unrealized gain, consider a tax-deferred exchange into a diversified basket. Options include a 1031 exchange (for investment real estate) or an exchange fund (for stocks). That could make it much easier to hold until your death.
6. If you are married and own assets in separate trust accounts, even out the unrealized gains between accounts. The benefit: assuming you cannot predict which spouse will pass away first, having similar unrealized gain in each trust means there will be assets the survivor can sell with no taxable gain during his or her remaining lifetime, regardless of who dies first. Remember, spouses can give each other assets with no tax impact.

The step-up at death is a gift from Congress. It has been around for more than a century. Some observers believe it could be revoked to narrow the budget deficit. That’s possible. But especially if you are retired, it’s probably a reasonable bet to assume the step-up will still be in place when you die. That creates a real planning opportunity.