When it comes to real estate, most people focus on the obvious—mortgage rates and neighborhood values. But there’s a quieter financial reality lurking in the tax code that can make an enormous difference to families: the step-up in basis. It’s an under-appreciated rule that can mean the difference between a six-figure tax bill and zero taxes owed. Let’s break it down with a familiar example.

Imagine Mrs. Smith purchases her family home for $100,000. That purchase price is her basis—the starting point the IRS uses to calculate gain or loss when the property is sold. Over the years, she pours love (and money) into the home. She adds an addition, renovates the kitchen, and upgrades the roof. These capital improvements increase her basis. So, while she paid $100,000 originally, let’s say she spent another $100,000 on improvements. Her adjusted basis is now $200,000.

Fast-forward 30 years: the neighborhood has boomed, and the home is now worth $700,000. On paper, that’s a $500,000 gain ($700,000 value minus $200,000 basis). If Mrs. Smith sells while alive, she can exclude $250,000 of that gain under the primary residence exclusion, but the remaining $250,000 is taxable. At roughly 20% combined federal and state capital gains rates, that’s a $50,000 tax bill.

Death and Taxes—But Sometimes, Less of Both

Here’s where the step-up in basis works its magic. If Mrs. Smith passes away still owning the home, the property receives a new basis equal to the fair market value on her date of death. That means her heirs’ starting point for tax purposes isn’t the $200,000 she invested, but the $700,000 the house is worth today.

What’s the practical effect? If her children sell the home the day after her death for $700,000, they owe zero capital gains tax. The step-up wipes away decades of appreciation. Even if they hold the home a few years and it grows to $750,000 before selling, they only pay tax on the $50,000 growth since her death. It’s one of the few true tax “free passes” in the system.

What About Trusts? Clearing Up Common Confusion

This is where estate planning meets tax law, and misconceptions abound. Many people believe they must create a trust to secure the step-up. Not so.

Revocable Living Trusts. If Mrs. Smith had placed her home into a revocable living trust, the result is the same. Because she retained full control during her life—the ability to change terms, revoke it, or sell the house—the IRS treats her as the owner. When she dies, the property in the trust also receives a step-up in basis. The trust avoids probate, but it doesn’t alter the tax outcome.

Irrevocable Trusts with Retained Powers. Suppose instead she created an irrevocable trust. Normally, assets in such trusts are outside her estate, meaning they would not automatically qualify for a step-up. But there’s a key exception: if she retains certain rights—like the power to change beneficiaries through her will (known as a “limited testamentary power of appointment”)—the IRS still pulls the property back into her taxable estate. In that case, her house would still get a step-up.

The Bigger Picture

The step-up in basis is a powerful reminder that timing and ownership structures matter as much as the raw numbers on a sale. While revocable living trusts can streamline estate administration, they don’t provide extra basis benefits—those are built into the system as long as the owner dies holding the property in a way that keeps it in their estate. For families sitting on highly appreciated homes, that quirk of the tax code can translate into life-changing savings. In Mrs. Smith’s case, it’s the difference between handing her children a home worth $700,000 free of capital gains tax—or saddling them with a bill that could top $50,000.

Final Word

Death and taxes may be inevitable, but not all taxes are equal. The step-up in basis is one of the few ways the tax code truly erases a lifetime of paper gains. Whether property is owned outright, in a revocable trust, or even in a carefully drafted irrevocable trust, understanding how this rule works can mean keeping hundreds of thousands of dollars in the family. And that’s a legacy Mrs. Smith—and countless homeowners like her—would no doubt be proud to leave behind.