Rebasing Capital Gains Tax: Step-Up, Exceptions, and Reporting

Rebasing capital gains tax means resetting an asset’s cost basis to its fair market value at a specific triggering event, most often the owner’s death. Once the basis is reset, tax applies only to appreciation that happens after that point, and decades of built-up gain can effectively disappear. In the United States the mechanism is called a step-up in basis, and it lives in Section 1014 of the Internal Revenue Code.¹

How the Reset Works at Death

When someone dies, every asset they owned takes on a new cost basis equal to its fair market value on the date of death.¹ In most cases the property has appreciated, so the new basis is higher than what the decedent paid, which is why the reset is usually a “step-up.”

A concrete example: your parent bought a home in 1985 for $80,000, and it’s worth $600,000 on the day they die. If you inherit it, your basis is $600,000. Sell for $620,000 a year later and you owe capital gains tax on $20,000, not on the $540,000 the property gained during your parent’s lifetime. That earlier appreciation is never taxed.

The reset applies to real estate, stocks, bonds, business interests, and tangible personal property like art or collectibles, whether the property passes under a will, through intestate succession, or from certain revocable trusts.¹ Inherited property is also automatically treated as long-term, no matter how quickly you sell, so any post-death gain qualifies for the lower long-term capital gains rates.

Calculating the Gain After a Basis Reset

The math is straightforward. Subtract the rebased basis from the sale price; the difference is your taxable gain. Inherit property valued at $500,000, sell later for $750,000, and $250,000 is taxable.

You can lower that gain by adding qualifying improvements made after the rebasing event. A $50,000 kitchen renovation and roof replacement pushes an adjusted basis of $500,000 to $550,000, dropping the taxable gain to $200,000.² Routine maintenance like painting or fixing a faucet does not count. An improvement has to add value, extend useful life, or adapt the property to a new use.³

Depreciation Recapture on Inherited Rental Property

If the decedent was renting the property and claiming depreciation, the step-up wipes out that depreciation history. Normally selling a depreciated asset triggers recapture tax of up to 25%, but the basis reset closes the gap the IRS would otherwise recapture. If you keep renting the inherited property and claim your own depreciation, though, that new depreciation is yours to recapture when you eventually sell.

Rates That Apply to the Post-Reset Gain

Once you have the gain figure, the rate depends on your total taxable income. For 2026, long-term capital gains fall into three brackets:

0% on taxable income up to $49,450 for single filers, $98,900 for married couples filing jointly, and $66,200 for heads of household.
15% on income above those figures up to $545,500 (single), $613,700 (joint), or $579,600 (head of household).
20% on income exceeding those thresholds.

These cutoffs adjust for inflation each year. On top of the base rate, the 3.8% net investment income tax applies to capital gains when modified adjusted gross income exceeds $200,000 for singles or $250,000 for joint filers, which brings the effective top rate to 23.8%.⁴ The NIIT thresholds are not indexed and have held steady since 2013.⁵

When Rebasing Does Not Apply

The step-up is not universal, and assuming it covers a transfer that it doesn’t is one of the more expensive tax mistakes.

Lifetime Gifts

Property given away while the donor is alive gets no reset. The recipient takes the donor’s original basis, called carryover basis. If your parent bought stock for $10,000 and gifts it to you during their lifetime, your basis is $10,000, regardless of the stock’s value on the day of the gift.⁶

There is a wrinkle for property that has lost value. If the donor’s basis is higher than fair market value on the gift date, the recipient must use the lower fair market value when calculating a loss on a later sale.⁶ If the donor paid gift tax, the recipient can increase basis by the portion of the tax attributable to net appreciation.⁷

The practical planning point: an elderly relative sitting on highly appreciated stock often saves the family more tax by holding the position until death than by transferring it during life.

Retirement Accounts and Income in Respect of a Decedent

Traditional IRAs, 401(k)s, and other tax-deferred accounts get no step-up. The money in them was never taxed on the way in, so distributions remain ordinary income to whoever inherits the account. This is part of a broader category called income in respect of a decedent, which also covers unpaid wages, deferred compensation, and installment sale receivables. Each keeps the tax character it would have had in the decedent’s hands.⁸

The One-Year Anti-Abuse Rule

Section 1014(e) blocks a specific loop: gifting appreciated property to a dying relative, letting the step-up happen at death, and inheriting it back with a fresh higher basis. If you give appreciated property to someone who dies within one year and the property returns to you or your spouse through the estate, the basis does not step up. It stays at the decedent’s adjusted basis immediately before death, which is your original carryover basis.⁹ The rule only bites when the property comes back to the original donor or their spouse. If it passes to someone else, the normal step-up applies even within the one-year window.

How Ownership Form Changes the Reset

Two people can own the same asset and get very different basis outcomes when one of them dies. The form of ownership drives the result.

Community Property and the Double Step-Up

In the nine community property states, both halves of jointly owned marital property step up when one spouse dies. The surviving spouse’s own half rebases along with the deceased spouse’s half, giving a complete reset on the whole asset.¹

Take a couple who bought a home for $200,000 that is worth $800,000 when one spouse dies. In a community property state, the survivor’s basis in the entire home becomes $800,000, and selling immediately would produce no capital gains tax. In a non-community-property state, only the deceased spouse’s half steps up, so the survivor’s basis is $500,000: their original $100,000 on their half plus a $400,000 stepped-up basis on the deceased spouse’s half. A handful of other states allow married couples to opt into community property treatment through special trusts.

Joint Tenancy Between Non-Spouses

When non-spouses hold property as joint tenants with right of survivorship, only the deceased owner’s fractional share steps up. Two siblings each owning half of a rental property, one dies, and the survivor gets a stepped-up basis on the deceased sibling’s 50% while keeping their original basis on their own half. The result is a blended basis somewhere between original cost and current market value.

The Alternate Valuation Date

The default rebasing date is the date of death, but an executor can elect to value the estate six months later under Section 2032. Property sold or distributed inside that six-month window is valued on the date it leaves the estate, not the six-month mark. The executor can only make the election if it lowers both the total estate value and the estate tax owed, and the choice is irrevocable once made.¹⁰ If no estate tax is due, the election is unavailable. The tradeoff to weigh: a lower valuation cuts the estate tax but also lowers the heir’s stepped-up basis, which can produce a larger capital gains bill when the property is sold.

Documenting the Rebased Value

The rebased value is the number every future calculation rests on, and the IRS expects you to be able to prove it. For real estate, a professional appraisal reconstructing market value as of the date of death is the standard. Fees typically run $300 to $700. For publicly traded stocks and mutual funds, the value is the average of the high and low trading prices on the date of death; if that date falls on a weekend or holiday, average the values on the trading days on either side.

Closely held businesses and limited partnership interests are harder to value and often qualify for discounts reflecting lack of marketability and lack of control. These discounts can range from 10% to 45% and almost always require a qualified business appraiser. They also draw audit attention.

The taxpayer carries the burden of substantiating any basis claimed, and missing records can lead the IRS to assign a lower value or, at worst, treat the basis as zero.¹¹ Keep appraisals, brokerage statements, and estate documents somewhere you can find them years later.¹²

Reporting the Sale

Sales of inherited property go on Form 8949 and flow to Schedule D of Form 1040.¹³ The critical entry is the stepped-up basis, not the decedent’s original purchase price. Using the wrong figure here is what triggers downstream problems.

Basis Consistency

For estates required to file Form 706, the executor also files Form 8971, which reports each asset’s value to both the IRS and the beneficiaries.¹⁴ Under Section 1014(f), a beneficiary’s basis cannot exceed the value reported on the estate tax return.⁹ Claiming a higher basis than what appeared on Form 706 is specifically listed as a trigger for accuracy-related penalties.

Penalties and the Audit Window

The IRS generally has three years from the date you file to question the return.¹⁵ Underreporting gain by more than 25% of gross income extends that to six years. Late payment carries a 0.5% monthly penalty on the unpaid amount, capped at 25%.¹⁶ The accuracy-related penalty, which adds 20% of the underpayment for negligence, substantial understatement, or valuation misstatement, is the bigger risk.¹⁷ Basis consistency errors on inherited property are explicitly among the triggers.

A Note on the UK Meaning

If you’re researching “rebasing” in a British tax context, the term describes something different. UK capital gains tax was rebased to March 31, 1982, so any asset held before that date is treated as sold and repurchased at its market value on that date, and only gains after March 1982 are taxed.¹⁸¹⁹ The United States has no equivalent legislative rebase across the board; the American system resets basis one asset at a time, triggered by events like death and certain tax-free exchanges.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
Internal Revenue Service. Internal Revenue Service Publication 551 – Basis of Assets
3
Internal Revenue Service. Publication 523 – Selling Your Home
4
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
5
Internal Revenue Service. Net Investment Income Tax
6
Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
7
Internal Revenue Service. Property (Basis, Sale of Home, etc.)
8
Office of the Law Revision Counsel. 26 US Code 691 – Recipients of Income in Respect of Decedents
9
Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
10
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
11
Internal Revenue Service. Burden of Proof
12
Office of the Law Revision Counsel. 26 US Code 7491 – Burden of Proof
13
Internal Revenue Service. About Form 8949, Sales and Other Dispositions of Capital Assets
14
Internal Revenue Service. About Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent
15
Internal Revenue Service. Time IRS Can Assess Tax
16
Internal Revenue Service. Failure to Pay Penalty
17
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
18
HM Revenue & Customs. Capital Gains Manual – CG10240
19
legislation.gov.uk. Taxation of Chargeable Gains Act 1992