IRS Section 1014: Step-Up in Basis on Inherited Assets

The step-up in basis on inherited assets resets your tax basis in most property you inherit to its fair market value on the date the previous owner died, replacing whatever that person originally paid. The practical effect is that the appreciation built up during the decedent’s lifetime is wiped off the tax ledger, so if you sell soon after inheriting, you may owe little or no capital gains tax. The rule comes from Section 1014 of the Internal Revenue Code.¹

How the Reset Works

Every asset carries a tax basis, which is essentially its cost for tax purposes. If a parent bought stock for $10,000 and it was worth $200,000 on the day they died, you inherit it with a basis of $200,000. The $190,000 of lifetime appreciation is never subject to income tax. Sell the next day for $200,000 and your taxable gain is zero.

The reset applies to property included in the decedent’s gross estate for federal estate tax purposes: real estate, brokerage accounts, business interests, and tangible personal property like art, jewelry, or vehicles. Foreign real estate owned by the decedent qualifies too.

The same rule can work against you. If your parent paid $100,000 for stock worth $40,000 at death, your basis steps down to $40,000, and the $60,000 of built-in loss disappears. Nobody gets to claim it.

Setting the Fair Market Value

The number you use as your new basis is whatever the asset was worth on the date of death. For publicly traded securities, that’s typically the average of the highest and lowest quoted selling prices on that trading day.² For real estate, you need a formal appraisal from a qualified appraiser reflecting market conditions as of the date of death. Keep that appraisal permanently; it is your primary evidence if the IRS questions your basis years later when you sell.

Executors of larger estates have one alternative. They can elect to value all assets six months after the date of death, called the alternate valuation date. The election is only available if it both reduces the total gross estate value and reduces the estate tax liability.³ Once made on Form 706, it’s irrevocable and applies to every asset in the estate.

There is a catch for heirs. The alternate valuation date typically produces lower values, which is the entire point for estate tax purposes, but it also lowers your stepped-up basis. A choice that saves the estate money on estate tax can mean more capital gains tax for you when you eventually sell.

What Qualifies and What Doesn’t

Most assets a person owned at death receive the step-up. The significant exception is what the tax code calls income in respect of a decedent, or IRD: assets representing income the decedent earned but never reported on a tax return.¹ The common ones:

Traditional IRAs and 401(k) plans. The money was tax-deferred during the decedent’s lifetime, and withdrawals remain taxable as ordinary income to the beneficiary.
Annuities. The tax-deferred growth portion is taxed as ordinary income when distributed.
Installment sale receivables. Remaining payments owed to the decedent keep their built-in gain.
Unpaid compensation and deferred bonuses the decedent had earned but not received.

The reason IRD assets are excluded is that the step-up exists to prevent double taxation of appreciation that would otherwise face both estate tax and income tax. IRD was never taxed during the decedent’s lifetime at all, and giving it a step-up would let the income permanently escape taxation.

How Marriage and Ownership Form Change the Math

If the decedent was married, how the couple held title can swing the step-up by hundreds of thousands of dollars.

Community Property States

In community property states, both halves of community property receive a step-up when either spouse dies, not just the deceased spouse’s share.² A couple who bought a home for $200,000 that’s now worth $800,000 at the first spouse’s death gives the survivor a new basis of $800,000 in the entire property. The full $600,000 of appreciation vanishes for tax purposes.

The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. At least half the community interest must be includible in the decedent’s gross estate for this double step-up to apply.

Joint Tenancy in Other States

Elsewhere, property held in joint tenancy or tenancy by the entirety gets a step-up only on the decedent’s share. The surviving owner’s half keeps its original basis.² Using the same $200,000 house now worth $800,000, the survivor’s basis becomes $500,000: $100,000 original basis on their half, plus $400,000 stepped-up basis on the decedent’s half. Selling the house would then produce $300,000 of taxable gain instead of zero.

Property Held in Trusts

Assets in a revocable living trust qualify for the step-up. The trust is disregarded for tax purposes during the grantor’s lifetime, the assets are included in the gross estate at death, and beneficiaries receive the same stepped-up basis they would from a direct inheritance.

Irrevocable grantor trusts are different. In Revenue Ruling 2023-2, the IRS confirmed that assets held in an irrevocable grantor trust do not receive a step-up if they aren’t included in the grantor’s gross estate.⁴ This affects grantor retained annuity trusts, qualified personal residence trusts, insurance trusts, and similar structures. Some irrevocable trusts are deliberately drafted so their assets stay in the gross estate (through retained powers, for example), and those assets do get the step-up. For 2026, the federal estate tax exemption is $15,000,000, which changes the planning calculus for many families.⁵

What You’ll Owe When You Sell

The calculation is straightforward: sale price minus your stepped-up basis equals your taxable gain. If your basis after the step-up is $400,000 and you sell for $410,000, you owe tax on $10,000.

Inherited property automatically qualifies for long-term capital gains treatment regardless of how long you actually hold it. Even a sale the day after you inherit gets long-term rates.⁶ For 2026, the long-term rates are:

0% on taxable income up to $49,450 (single) or $98,900 (married filing jointly).
15% from those thresholds up to $545,500 (single) or $613,700 (married filing jointly).
20% above $545,500 (single) or $613,700 (married filing jointly).

Higher-income beneficiaries may also owe the 3.8% net investment income tax if modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), bringing the maximum federal rate on long-term gains to 23.8%.⁷ You report the sale on Form 8949 and Schedule D of Form 1040.⁸

The Basis Number You’re Required to Use

If the estate was large enough to require Form 706 (generally gross assets exceeding $15,000,000 for decedents dying in 2026), the executor must also file Form 8971 and give each beneficiary a Schedule A showing the reported value of their inherited property.⁹ Form 8971 is due within 30 days of the earlier of when Form 706 is due or when it’s filed.

That Schedule A is not just informational. Under the consistent basis rule in Section 1014(f), for property that increased the estate tax liability, your basis cannot exceed the value reported on the estate return.¹⁰ Report a higher basis when you sell and the IRS catches it, and you face a 20% accuracy-related penalty on the resulting underpayment.¹¹

For estates below the filing threshold, no Form 706 and no Schedule A arrive. Your basis is still the date-of-death fair market value, but you’ll need your own documentation (an appraisal for real estate, brokerage statements for securities) to support the figure you put on your return.

One Limit on Deathbed Planning

Section 1014(e) blocks a specific maneuver. If you gift appreciated property to someone, they die within one year, and the property passes back to you or your spouse, you don’t get a step-up. Your basis is whatever the decedent’s adjusted basis was immediately before death, which is typically your original basis. The rule only applies when the property returns to the original donor or the donor’s spouse. If it goes to a different beneficiary, or if the donee survives more than a year, the step-up works normally.

Why Inheritance Beats a Lifetime Gift for Appreciated Assets

Property received as a gift during the donor’s lifetime generally takes the donor’s original basis, which the tax code calls carryover basis.¹² A parent who gifts you stock they bought for $5,000 that is now worth $150,000 leaves you with a $5,000 basis and a $145,000 built-in gain. Inherit the same stock and your basis jumps to $150,000.

That contrast drives a familiar estate planning conclusion: highly appreciated assets are usually better held until death so heirs get the step-up. The opposite reasoning applies to assets that have lost value. Those are often better sold or gifted during the owner’s lifetime so the owner can claim the capital loss. If a depreciated asset passes through the estate, the step-down locks in the lower basis and the loss is gone for good.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
Internal Revenue Service. Publication 551 – Basis of Assets
3
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
4
Internal Revenue Service. Internal Revenue Bulletin 2023-16 – Revenue Ruling 2023-2
5
Internal Revenue Service. What’s New – Estate and Gift Tax
6
Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property
7
Internal Revenue Service. Net Investment Income Tax
8
Internal Revenue Service. Instructions for Form 8949 – Sales and Other Dispositions of Capital Assets
9
Internal Revenue Service. Instructions for Form 8971
10
Internal Revenue Service. Schedule A (Form 8971) – Beneficiary Information Regarding Property Acquired From a Decedent
11
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty
12
Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust