What Is a Step-Up in Basis? How It Works for Inherited Property

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A step-up in basis is a federal tax rule that resets the cost basis of an inherited asset to its fair market value on the date the original owner died. When an heir later sells, capital gains tax is measured from that date-of-death value, not from what the deceased originally paid. Any appreciation that built up during the owner’s lifetime is never taxed as a capital gain. The rule comes from Section 1014 of the Internal Revenue Code and applies to stocks, bonds, mutual funds, real estate and other capital assets that pass at death.

How a Step-Up in Basis Works

Cost basis is the starting point for figuring gain or loss. It begins with the purchase price and is adjusted over time. For example, it is increased by capital improvements to a home or reduced by depreciation on a rental. Gain on a sale is the amount realized minus the adjusted basis.

When an owner dies, that history stops mattering for the heir. The new basis is set by valuation, not by calculation:

Heir’s basis = fair market value of the asset on the date of death

The step-up happens automatically at death. The heir files nothing to claim it but must be able to document the value when selling. For publicly traded stock, fair market value is generally the mean of that day’s high and low prices, not the closing price. Real estate, private business interests and collectibles usually require a qualified appraisal as of the date of death.

Two further rules shape the result:

• Alternate valuation date. If an estate files a federal estate tax return, the executor may elect to value assets six months after death instead. The election is available only if it reduces both the gross estate and the estate tax owed, and the heirs’ basis then follows that alternate value.
• Holding period. Inherited property is treated as held long-term, even if the heir sells it a week after the owner’s death. Any gain above the stepped-up basis is therefore taxed at long-term capital gains tax rates.

The heir reports the eventual sale on their own return using the stepped-up figure as basis. Brokerages often update the cost basis on inherited shares, but the heir is responsible for the number reported to the IRS. If an estate tax return was filed, the basis an heir reports generally has to be consistent with the value finally determined for estate tax purposes.

Example of a Step-Up in Basis

Hypothetical example. Maria bought 1,000 shares of a stock for $20 each, a total basis of $20,000. When she dies, the shares are worth $150,000. Her son inherits them.

If the son holds the shares and later sells them for $170,000, his taxable gain is $20,000, which is only the growth after his mother’s death.

The same logic applies to real estate. Hypothetical: a house bought for $90,000, with $30,000 of documented improvements (adjusted basis $120,000), is appraised at $500,000 when the owner dies. If the heirs sell it shortly afterward for $500,000, they owe no capital gains tax, and selling costs such as agent commissions may produce a small deductible loss. This holds whether the estate or the heirs sell, with any later improvements added to the date-of-death basis.

The Step-Down: When Assets Have Lost Value

The rule is symmetrical. If Maria’s shares had fallen to $8,000 by the time she died, her son’s basis would be $8,000, not $20,000. Her $12,000 unrealized loss could not be used by anyone. Owners holding assets well below their purchase price sometimes sell them during life to realize the loss for their own tax purposes rather than let it vanish at death.

Spouses, Joint Ownership and Community Property

How much of a married couple’s property steps up when the first spouse dies depends on how it was owned and where the couple lived.

Separate property of the deceased spouse. An asset owned solely by the spouse who died gets a full step-up when it passes to the survivor.

Joint property in common-law states. For assets held jointly by spouses (such as a joint brokerage account or a house held as joint tenants), only the deceased spouse’s half is included in the estate, so only that half steps up. Hypothetical: a joint account worth $200,000 with a $100,000 basis. The deceased spouse’s half takes a new basis of $100,000; the survivor’s half keeps its original $50,000. The survivor’s total basis becomes $150,000.

Community property states. Nine states use community property rules: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Federal law gives community property a step-up on both halves when one spouse dies, often called the double step-up. In the example above, the survivor’s basis would be the full $200,000. Community property generally means assets acquired during the marriage, excluding gifts and inheritances received by one spouse.

Community property trusts. Alaska, Kentucky, South Dakota and Tennessee let couples, including non-residents in some cases, place assets in a community property trust designed to qualify for the same treatment.

For unmarried joint owners, the general rule is that the portion stepped up depends on how much of the asset’s cost the deceased contributed, so records of who paid for what matter.

What Does Not Get a Step-Up

The step-up applies to property acquired from a decedent. Several common situations fall outside it:

• Lifetime gifts. Property received as a gift generally keeps the donor’s basis (carryover basis). Parents who give appreciated stock to a child pass along the full built-in gain; the same stock left by will would have stepped up.
• Retirement accounts and annuities. Traditional IRAs, 401(k)s and similar accounts hold pre-tax money that counts as income in respect of a decedent. Beneficiaries pay ordinary income tax on withdrawals, with no step-up. Roth accounts are a separate case because qualified withdrawals are already tax-free.
• Gifts returned at death. If someone gives appreciated property to a person who dies within one year and the property comes back to the original donor (or the donor’s spouse), there is no step-up.
• Assets outside the taxable estate. A step-up generally depends on the asset being included in the decedent’s estate. Assets in a revocable living trust qualify. The IRS ruled in 2023 that assets in an irrevocable grantor trust that are excluded from the estate do not receive a step-up merely because the grantor dies.

Step-Up in Basis vs. the Estate Tax

The two are often confused. The estate tax is a tax on the total value of what a person leaves, paid by the estate. The step-up is an income tax rule that sets the heir’s basis, and it applies even when no estate tax is owed, as is the case for the overwhelming majority of estates. After the 2017 tax law doubled the exemption, about 0.04% of adult deaths in 2020 produced estate tax liability, according to one analysis.

Criticism and Proposals to Change It

Critics call the step-up one of the largest loopholes in the tax code. Owners of large, long-held appreciated assets can avoid selling, borrow against those assets for cash, and pass the gains to heirs untaxed. The Congressional Budget Office has estimated that more than half of the provision’s benefit goes to the top 5% of households by income, and budget groups put its revenue cost at tens of billions of dollars a year.

Defenders argue that taxing gains at death would discourage saving, hurt family farms and small businesses with illiquid assets, double-tax estates that also pay estate tax, and require reconstructing basis for assets bought decades earlier.

Repeal attempts have failed. Congress enacted a carryover basis regime in 1976 but repealed it before it took effect. A 2021 proposal to tax gains at death above $2.5 million per married couple, plus $250,000 for a home, did not pass. Because the rule is set by statute, Congress could still change it by amending Section 1014.

FAQs

The Bottom Line

Heirs who inherit appreciated stock, real estate or other capital assets can often sell with little or no capital gains tax, as long as they document the date-of-death value. Married couples and owners planning gifts should look at how assets are titled, since joint ownership, community property and lifetime gifts change how much basis steps up. The rule is set by statute, so Congress could still amend it.