Do Inherited Savings Bonds Get a Stepped-Up Basis?

Inherited savings bonds do not get a stepped-up basis. The interest that built up during the original owner’s lifetime is treated as income in respect of a decedent, and Internal Revenue Code Section 1014 specifically excludes that category from the step-up rule. Whoever cashes the bond owes ordinary federal income tax on every dollar of accrued interest, from the purchase date forward, unless the executor took a specific step on the decedent’s final return to shift part of that burden.

Why the Step-Up Rule Skips Savings Bonds

Section 1014 resets the cost basis of inherited property to its fair market value on the owner’s date of death.¹ A stock bought at $20 and worth $100 at death becomes a $100 basis in the heir’s hands. Sell at $100, owe nothing.

Savings bonds don’t grow through market appreciation. A Series EE or Series I bond gains value only through interest that accrues over time, and most owners choose to defer reporting that interest, letting it compound untaxed until redemption or maturity. When the owner dies without ever reporting it, the untaxed interest becomes Income in Respect of a Decedent, or IRD: income the deceased earned but never put on a return.²

Section 1014 carves IRD out of the step-up rule, and the IRS confirms that savings bonds acquired from a decedent are a specific type of IRD.³ The beneficiary takes the bond at the decedent’s original cost basis. All the accumulated interest stays taxable as ordinary income when the bond is cashed or matures.

Who Ends Up Owing the Tax

The person on the hook depends on how the bond is registered. If the bond lists a surviving co-owner, ownership passes directly to that person outside the estate, and the co-owner becomes responsible for all accrued interest at redemption.⁴ A payable-on-death beneficiary takes ownership the same way, with the same tax result. If no co-owner or beneficiary is named, the bond falls into the estate and the executor decides whether to redeem or distribute.

In every case, the person who ultimately cashes the bond receives a 1099-INT showing the full lifetime interest and owes tax on that full amount, unless the executor made the election described next.⁵

The Executor’s Election That Can Shift the Burden

The executor can elect to include all interest accrued through the date of death on the decedent’s final Form 1040. This removes the pre-death interest from its IRD status.³ Once filed, the election is irrevocable.

The math is simple when the final-year rate is lower than the beneficiary’s rate. Someone who dies early in the year with minimal income may sit in a 12% bracket while the beneficiary sits at 24%. Reporting $30,000 of bond interest at the lower rate saves real money. The beneficiary’s basis then rises by the amount of interest already reported, and the beneficiary owes tax only on interest that accrues from the date of death to the date the bond is actually cashed. Post-death interest keeps its tax-deferred status until redemption or maturity.³

The trade-off: the election costs the estate money now. When the decedent’s final-year rate sits close to the beneficiary’s, the savings may not justify the cash outlay.

Deferring or Redeeming After You Inherit

If no election was made, you inherit the bond with every dollar of deferred interest still attached. Two options follow.

You can hold the bond and let interest keep accruing untaxed until you redeem it or it reaches final maturity. No tax is owed in the meantime. That path works if you expect a lower bracket later, perhaps in retirement. Watch the maturity date: once a bond matures, the IRS treats the full interest as received that year whether you cash the bond or not.⁶

Alternatively, you can cash the bonds and report all accrued interest in the year of redemption. This is ordinary income taxed at your marginal rate, not at capital gains rates.⁷ Schedule B is required once your total interest income for the year passes $1,500.⁸ A large stack of bonds cashed all at once can push you into a higher bracket; spreading redemptions across several tax years keeps more of the interest taxed at lower rates.

Fixing the 1099-INT So You Aren’t Taxed Twice

This is where people get hurt at filing time. When you redeem an inherited bond, the 1099-INT shows all the interest the bond ever earned. It is not reduced by anything the executor already reported on the decedent’s final return.⁵

If the election was made, you have to adjust the amount or you’ll pay tax twice on the same dollars. The IRS directs you to use the nominee reporting procedure on Schedule B: enter the full 1099-INT amount on Line 1, then subtract the interest reported on the decedent’s final return with a short notation explaining the adjustment. Only the net figure flows into your taxable income.⁹ Keep a copy of the decedent’s final return in your files in case the IRS questions the subtraction.

TreasuryDirect puts it bluntly: “If you are the new owner who gets that 1099-INT, you must prove to the IRS that a portion of the interest was previously reported to a different owner.”⁷ Without that proof, you pay again on interest someone already paid tax on.

The IRD Deduction When Estate Tax Was Paid

If the decedent’s estate was large enough to owe federal estate tax, the accrued bond interest was already counted in the taxable estate. Section 691(c) prevents the same dollars from being taxed twice by letting the beneficiary deduct a proportional share of the estate tax attributable to IRD items.¹⁰ You claim it as an itemized deduction on Schedule A in the same year you report the bond interest.³

The calculation compares the estate tax actually paid to what it would have been without the IRD items, then allocates the difference to the interest you reported. Most people need a tax professional to run it. The deduction only helps when the estate owed federal estate tax at all; the current federal exemption is $15 million per person, so most estates won’t trigger any estate tax and have no 691(c) deduction to pass through.

The Education Exclusion Doesn’t Transfer

A separate rule often trips up heirs. Series EE and I bonds can qualify for a tax exclusion when redeemed for higher education expenses, but Section 135 requires that the bond was issued to someone at least 24 years old at purchase, and that the person redeeming it is the original purchaser or their spouse.¹¹ A beneficiary who inherits bonds from a parent or grandparent is not the original purchaser, so the exclusion is gone no matter what the money is spent on. A grandparent who bought bonds for a grandchild’s tuition had to redeem them personally and pay the qualified expenses while alive.

State and Local Taxes Still Don’t Apply

One favorable rule carries over to heirs. Savings bond interest is exempt from state and local income taxes, inherited or not.⁷ Only federal income tax hits the interest. In a high-tax state, that exemption meaningfully narrows the gap between an inherited bond and an inherited investment that would have received the step-up but owes state tax on future gains.

1
Office of the Law Revision Counsel. 26 U.S.C. 1014 – Basis of Property Acquired From a Decedent
2
eCFR. 26 CFR 1.691(a)-1 – Income in Respect of a Decedent
3
Internal Revenue Service. Publication 559, Survivors, Executors, and Administrators
4
TreasuryDirect. Death of a Savings Bond Owner
5
Internal Revenue Service. Publication 550, Investment Income and Expenses
6
TreasuryDirect. Comparing EE and I Bonds
7
TreasuryDirect. Tax Information for EE and I Bonds
8
Internal Revenue Service. Savings Bonds 1
9
Internal Revenue Service. Instructions for Schedule B (Form 1040)
10
Office of the Law Revision Counsel. 26 U.S. Code 691 – Recipients of Income in Respect of Decedents
11
Office of the Law Revision Counsel. 26 U.S. Code 135 – Income From United States Savings Bonds Used to Pay Higher Education Tuition and Fees