Direct answer: This page walks through a complete estate transfer analysis for a married couple with a $3.5 million estate. The key findings: the brokerage account's $250,000 embedded capital gain is entirely eliminated by the step-up in basis at death, saving approximately $47,600 in federal capital gains tax. The home would pass through probate without a revocable trust, adding cost and delay. A state with a $2 million estate tax exemption would impose state estate tax on the excess. And a beneficiary designation audit reveals the IRA is correctly designated but exposes the need to name contingent beneficiaries.
Estate Transfer in Practice: Worked Example and Portfolio Context
The Scenario: A $3.5 Million Married Couple's Estate
Consider a married couple, both in their early 60s, with the following asset inventory totaling $3.5 million:
| Asset | Value | Cost Basis | Embedded Gain | Current Title / Designation |
|---|---|---|---|---|
| Primary residence | $1,200,000 | $400,000 | $800,000 | Titled jointly in both names (JTWROS) |
| Taxable brokerage account | $800,000 | $550,000 | $250,000 | Individual account, no TOD registration |
| 401(k) | $900,000 | N/A (pre-tax) | N/A | Spouse named as primary beneficiary |
| Traditional IRA | $600,000 | N/A (pre-tax) | N/A | Spouse named as primary; no contingent beneficiary |
Step 1: Identify the Transfer Mechanism for Each Asset
Primary Residence ($1,200,000)
The home is titled as joint tenants with right of survivorship (JTWROS). At the first spouse's death, the surviving spouse automatically inherits the full home outside of probate. No court process, no delay. At the second spouse's death, however, the home is now solely owned by the surviving spouse and will pass through probate unless a revocable living trust is established or a TOD deed is recorded where state law permits. The surviving spouse should consider retitling the home into a revocable trust to avoid probate at the second death.
Taxable Brokerage Account ($800,000)
This account has no TOD registration and is individually owned. At death, it passes through the will and into probate. This is a straightforward fix: add a TOD registration with the custodian naming the intended beneficiary (or the trust). The fix requires completing a form with the brokerage, not creating a new document or incurring legal fees.
401(k) ($900,000)
The 401(k) correctly names the spouse as primary beneficiary. At the first spouse's death, the surviving spouse inherits the 401(k) and may roll it into their own IRA, deferring all distributions until they reach their own required beginning date. A key gap: no contingent beneficiary is named. If the spouse predeceases the account owner, the 401(k) would pass to the estate by default, triggering the accelerated distribution problem described in the risks article of this cluster.
Traditional IRA ($600,000)
The IRA names the spouse as primary beneficiary but has no contingent beneficiary. Same gap as the 401(k). Both should be updated to name children per stirpes (or a trust if the children are minors or have special needs) as contingent beneficiaries.
Step 2: Calculate the Step-Up in Basis Savings on the Brokerage Account
The taxable brokerage account has $250,000 in unrealized capital gains ($800,000 fair market value minus $550,000 cost basis). If the owner sold all positions during their lifetime, the tax cost would be approximately:
- Federal long-term capital gains tax at 15%: $250,000 x 15% = $37,500
- Net Investment Income Tax at 3.8% (if income exceeds $250,000 married filing jointly threshold): $250,000 x 3.8% = $9,500
- Estimated federal tax: $47,000
If the owner holds until death, the heirs receive the account with a new basis of $800,000 (the fair market value on the date of death). They can sell every position immediately and owe zero federal capital gains tax on the $250,000 of embedded gain. The step-up eliminates approximately $47,000 in federal tax. Add any applicable state capital gains tax for the investor's state to compute the full benefit.
This calculation assumes the positions are still held at death. If the investor sells the positions during their lifetime for investment reasons, the tax is unavoidable. The step-up rule creates an incentive to hold appreciated taxable positions rather than rotating out of them, but only when the investment thesis still supports holding. Holding a losing investment purely for the step-up is counterproductive.
Step 3: State Estate Tax Exposure
Assume this couple lives in a state with a $2 million per-person estate tax exemption. Each spouse has a separate exemption. At the first spouse's death, all assets pass to the surviving spouse using the unlimited marital deduction, so no state estate tax is owed at the first death.
At the second spouse's death, the combined estate of $3.5 million (assuming no growth or spending) is subject to the state estate tax. The surviving spouse's exemption is $2 million, leaving $1.5 million subject to state estate tax. At a graduated state estate tax rate that averages roughly 10% to 16% on the excess, the state estate tax on $1.5 million would be approximately $100,000 to $240,000, depending on the specific state's rate schedule.
Strategies to address this exposure include: using a credit shelter trust (also called a bypass trust or family trust) at the first death to fully use the first spouse's exemption rather than deferring everything to the surviving spouse, making annual exclusion gifts to children ($18,000 per recipient per year in 2026), or relocating to a state without estate tax if that decision makes sense for non-tax reasons as well. Consult a qualified estate planning attorney before choosing any of these strategies.
Priority Actions for This Estate
- Add contingent beneficiaries to both the 401(k) and the IRA. This is the most urgent fix and requires only completing forms at the plan administrator and IRA custodian.
- Register the brokerage account with a TOD designation to avoid probate at death. The surviving spouse or the revocable trust should be named, as appropriate.
- Establish a revocable living trust and retitle the home into it to ensure the home bypasses probate at the surviving spouse's death. Also consider a pour-over will to capture any inadvertently untitled assets.
- Evaluate a credit shelter trust structure with an estate planning attorney to preserve the first spouse's state estate tax exemption rather than losing it to the marital deduction at the first death.
- Review all designations and title on a fixed annual schedule, updating as life events occur.
Frequently Asked Questions
How do I calculate the step-up in basis benefit on an inherited brokerage account?
The step-up in basis benefit equals the federal and state capital gains tax that would have been owed if the decedent had sold the appreciated positions during their lifetime, minus zero (the tax owed by the heir who inherits and sells immediately at the stepped-up basis). To calculate it: identify the embedded unrealized gain in each taxable account position (fair market value minus original cost basis), apply the applicable long-term capital gains rate (0%, 15%, or 20% federal, plus 3.8% NIIT if applicable, plus any state capital gains tax), and sum the result. That total is the tax eliminated by holding until death rather than selling. For large estates with concentrated low-basis positions, this benefit can easily exceed six figures.
How does a revocable trust avoid probate for a home?
A revocable living trust avoids probate for a home by making the trustee (rather than the individual) the legal owner of the property. The deed to the home is retitled from the individual's name to the trustee's name. When the grantor dies, the successor trustee named in the trust document takes over and distributes the home to the trust beneficiaries according to the trust terms, without any court process. The trust distribution terms remain private. Compare this to a will, which requires a probate court proceeding to authorize the transfer and becomes a public record.
What is the state estate tax risk for a $3.5 million estate?
A $3.5 million estate owes no federal estate tax because it falls far below the current federal exemption of $13.99 million per individual. However, if the estate is in a state with a lower estate tax exemption, it may owe state estate tax. Twelve states and Washington D.C. impose estate tax. States such as Massachusetts and Oregon apply estate tax on amounts above $1 million to $2 million respectively. An investor with a $3.5 million estate in such a state could owe substantial state estate tax on the excess above the state exemption, even with no federal liability.
References
- IRS: Publication 559, Survivors, Executors, and Administrators: the authoritative IRS publication on income tax obligations of estates and beneficiaries, step-up in basis under IRC section 1014, and income in respect of a decedent.
- IRS: Estate Tax Overview: IRS guidance on the federal estate tax, including the unlimited marital deduction, portability, and the current exemption amounts.
Estate and tax rules are subject to legislative change. This article uses illustrative numbers and general U.S. estate planning concepts as of August 2026. Actual tax exposure depends on individual facts, applicable state laws, and the current federal exemption. Nothing on this page is personalized legal, tax, or financial advice. Consult a qualified estate planning attorney for guidance specific to your situation.