Step-Up in Basis: Rebalancing an Inherited Portfolio in 2026

The death of a spouse resets the tax history of much of what you now own, and that reset can make the coming year the least expensive moment you will ever have to reshape a portfolio. For inherited property, federal tax law generally measures future gain from the value at death rather than from the original price, so shares bought decades ago, or a concentration no one dared to sell, may carry little embedded gain today.

The opportunity has edges. How much was reset depends on title and state law, single-filer brackets arrive far sooner than joint ones, and a clean slate can be squandered by careless trading. By the end of this guide you should be able to decide which holdings can be sold cheaply, where each remaining asset belongs, and whether loss harvesting or direct indexing earns its complexity.

What the reset does, and what it does not

IRS Publication 551 states the general rule: the basis of property inherited from a decedent is its fair market value at the date of death, or on the alternate valuation date if the estate’s personal representative elects it. Special-use valuation and conservation-easement land are narrower exceptions. The current publication, which already refers to the One Big Beautiful Bill Act (Public Law 119-21, enacted July 4, 2025), still states the rule this way.

The reset runs in both directions: a holding worth less at death than its cost takes the lower value, and the paper loss disappears. Publication 550 adds that a later sale of an inherited capital asset produces long-term gain or loss, however briefly you hold it. One exception matters for deathbed transfers: if you or your spouse gave appreciated property to the decedent during the year before death and you or your spouse then received that same property back, its basis is the decedent’s adjusted basis immediately before death rather than fair market value. When an estate must file Form 706, certain beneficiaries must use the value reported on Schedule A (Form 8971). Our guide to documenting inherited property basis covers the evidence behind each number.

How much of the portfolio was actually reset

In the nine community property states Publication 551 lists (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin), the total value of community property, including the half that was already yours, generally becomes the basis of the entire property, provided at least half of the community interest is includible in your spouse’s gross estate. Publication 555 does not address the elective community property regimes of Alaska, Tennessee and South Dakota, and some other states now permit community property trusts; if you used any such arrangement, ask counsel.

In common-law states, a qualified joint interest (tenancy by the entirety, or joint tenancy with right of survivorship where the spouses are the only joint tenants) works differently. Half its value is included in the decedent’s estate regardless of who paid, and your basis becomes the cost of your own half plus the basis of the half you inherited. Assets your spouse owned outright are generally reset in full; assets that were always yours are not reset at all.

Suppose, hypothetically, an account bought for $2,000,000 is worth $6,000,000 at your spouse’s death. Held as spousal joint tenants in a common-law state, your new basis is about $4,000,000: your $1,000,000 half of the cost plus $3,000,000 for the inherited half. Held as community property that qualifies for the full adjustment, the basis is $6,000,000. The arithmetic is simplified; the $2,000,000 difference is why this question comes first.

The cheapest rebalancing you may ever do

Once the reset is documented, a position that seemed untouchable can often be trimmed for the tax on whatever it has gained since the date of death. This is the practical value of the step-up, and it erodes as new gains accumulate.

That argues for prompt decisions, not hasty trades. Confirm authority over each account, the values the custodian has recorded, and the purpose each pool of money now serves; our guide to reviewing a portfolio you did not build sets out that order. When you sell part of a position, identify the lots. Publication 550 treats an instruction to your broker at the time of sale, confirmed in writing, as adequate identification; without one, the shares acquired first are generally treated as sold first.

The step-up does not tell you what to own; it only lowers the price of deciding.

Single-filer brackets arrive sooner than joint ones

The change does not come at once. Under IRS Publication 501, if you did not remarry before the year ended, you can file a joint return for the year your spouse died. For the two years after it, you may file as a qualifying surviving spouse, which uses the joint figures where the IRS tables say so, but only if a child or stepchild you can claim as a dependent lived in your home all year and you paid more than half the cost of keeping it up. Otherwise you will generally file as single, or as head of household if you qualify, from the year after the death. Once you file as a single taxpayer, every threshold moves closer. For 2026, from the 12 percent through the 35 percent bracket, each single threshold is exactly half the joint one: the 35 percent rate begins above $256,225 of taxable income for a single filer against $512,450 on a joint return. The 37 percent rate begins above $640,600 rather than $768,700. Under Revenue Procedure 2025-32, the 20 percent rate on long-term gains and qualified dividends begins above $545,500 of 2026 taxable income for single filers, against $613,700 for joint filers and surviving spouses.

The 3.8 percent net investment income tax applies to the lesser of net investment income or the amount by which modified adjusted gross income exceeds $200,000 for a single filer, or $250,000 for joint filers and qualifying surviving spouses. Suppose, hypothetically, you file as a single taxpayer, your 2026 MAGI is $450,000 and your net investment income is $300,000: the tax applies to the $250,000 excess, or $9,500. Tax-exempt municipal bond interest is outside it.

A trust that keeps its income is compressed further. For 2026 the top 37 percent rate for estates and trusts begins above $16,000 of taxable income, and the net investment income tax can reach a trust’s undistributed investment income once its adjusted gross income passes that same point.

Placing each asset where it is taxed most gently

Asset location is a recommendation, not a rule; the rules beneath it are these. Publication 550 says its rules do not apply to investments held in IRAs, 401(k) plans and other qualified plans, so rebalancing inside them creates no capital gain or loss in the year you trade. Tax on a traditional IRA is generally deferred until distribution, and qualified Roth IRA distributions are not included in gross income. In a taxable account, qualified dividends and net capital gain generally receive the 0, 15 or 20 percent rates, while interest is taxed with your other income.

One common starting pattern follows: place tax-inefficient taxable bonds in a traditional account, reserve scarce Roth space for assets with strong expected growth, and use the freshly reset taxable account for broad equity positions whose gains can be deferred and, if held for life, may be reset again for your heirs. It is not universal. Required distributions, liquidity, charitable plans, heirs’ tax situations, risk, and each account’s expected return can reverse the answer. Tax-exempt bonds gain nothing from a deferred wrapper, and money you will spend soon belongs where you can reach it. Record the chosen locations and reasoning in a written investment policy so rebalancing follows the plan, not the market’s mood.

Harvesting losses without tripping the wash sale rule

Because the step-up erased the losses that existed at death, harvesting begins only with later declines. Capital losses offset capital gains, and a net loss can reduce other income by up to $3,000 a year, with the rest carried forward until used. Your spouse’s losses are different: Publication 550 says a decedent’s capital loss can be deducted only on the final return, not carried over by the estate, and a split joint carryover belongs only to the spouse who had the loss.

The wash sale rule disallows a loss if, within 30 days before or after the sale, you buy substantially identical stock or securities, acquire them in a fully taxable trade, acquire an option to buy them, or acquire them in your IRA or Roth IRA. Ordinarily the disallowed loss is added to the basis of the replacement shares and merely postponed; when the replacement lands in an IRA or Roth IRA, Publication 550 makes no such adjustment. Automatic dividend reinvestment in a retirement account can therefore defeat an intended harvest.

Direct indexing, weighed honestly

Direct indexing replaces an index fund with a managed account that owns many of the index’s individual stocks, so losses on single names can be harvested even when the index rises. It can also exclude holdings, which helps beside a large inherited stake in one company or sector.

The costs are equally real: a management fee to set against a plain index fund’s expense, account minimums, and many lots, trades and pages of tax reporting. The harvesting benefit can fade as the account seasons, because each position that rises above its purchase price stops being a candidate and the portfolio drifts back toward locked-in gains. For an inherited portfolio, the step-up has already done much of what harvesting sets out to do. Direct indexing is most defensible for substantial new cash or a concentration being diversified over several years, once you have seen the all-in fee in dollars and the exit plan.

Questions to ask before the first trade

1. Which accounts received a full basis adjustment, which half, and which none?
2. Do the custodians’ recorded date-of-death values match the estate’s appraisals and any Schedule A (Form 8971)?
3. Which positions can be sold now for little gain, and what is the tax cost of each sale in dollars?
4. When do single-filer brackets first apply to me, and where does my projected income fall against the 2026 thresholds?
5. Where should each asset class sit across taxable, traditional and Roth accounts, and why?
6. Have my spouse’s own capital losses been used on the final return, and which carryovers remain mine?
7. How will you prevent wash sales across every account, including dividend reinvestment in IRAs?
8. For direct indexing, what are the annual cost in dollars, the minimum and the exit plan?
9. How will distributions from any trust holding part of the portfolio be coordinated with its brackets?

This article provides general U.S. educational information and is not legal, tax, accounting, or investment advice. Figures are for 2026 and change annually; confirm current rules with the IRS and a qualified professional who knows your facts.