Stepped-Up Basis for Inherited Property: Rules, Trusts, and Valuation

The stepped-up basis for inherited property resets the tax cost of what you inherit to its fair market value on the date the previous owner died, erasing decades of appreciation from the tax ledger. If your parent bought a home for $150,000 and it was worth $600,000 when they passed away, your starting basis is $600,000, not $150,000. When you eventually sell, you owe capital gains tax only on growth that happens after the death, not on anything that built up during the decedent’s lifetime. The rule sits in 26 U.S.C. § 1014 and is one of the most valuable tax breaks in the entire code.¹

How the Reset Works in Practice

Your new basis replaces whatever the deceased owner originally paid, including any improvements they made over the years. Say your uncle bought a commercial building for $300,000 and it’s worth $800,000 when he dies. Your basis becomes $800,000. If you sell for $850,000, you owe capital gains tax on the $50,000 of growth that happened after you inherited it. The $500,000 of appreciation during your uncle’s ownership is never taxed to anyone. That is the practical power of the rule, and it is why estate planners often recommend holding appreciated assets until death rather than giving them away during life.

When the Basis Steps Down

The adjustment cuts both ways. If the property lost value while the deceased owner held it, your basis resets to the lower fair market value at death. Suppose your parent bought stock for $50,000 and it was worth only $20,000 when they died. Your basis is $20,000, and you cannot claim a loss based on what they originally paid. This catches people off guard with volatile investments or real estate in declining markets. A lifetime gift can sometimes produce a better tax result for a recipient of a depreciated asset, because gift basis rules at least preserve the donor’s original higher basis for calculating gains, though special rules apply to losses.²

Automatic Long-Term Capital Gains Treatment

Whenever you sell inherited property, any gain is treated as a long-term capital gain no matter how quickly you sell. Under 26 U.S.C. § 1223(9), inherited property is deemed held for more than one year even if you sell the day after the funeral.³ Long-term rates are significantly lower than short-term rates, which are taxed as ordinary income.

For 2026, long-term capital gains are taxed at 0%, 15%, or 20% depending on your total taxable income.⁴ For single filers, the 0% rate applies up to $49,450 in taxable income, the 15% rate covers income up to $545,500, and the 20% rate kicks in above that threshold.

High-income heirs face a second layer. The 3.8% net investment income tax applies to capital gains when your modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married filing jointly.⁵ The effective top rate on inherited asset sales can reach 23.8%, not 20%. Easy to overlook, painful to discover on the return.

Which Assets Qualify

Any property included in the decedent’s gross estate is eligible for the basis adjustment. That covers real estate, stocks and bonds in taxable brokerage accounts, mutual funds, business interests, artwork, jewelry, collectibles, and digital assets.⁶ The step-up applies whether or not the estate is large enough to actually owe estate tax. For 2026, the estate tax filing threshold is $15,000,000.⁷ Most estates fall well below that number, but heirs still get the basis reset.

For property held as joint tenants with right of survivorship by non-spouses, only the portion included in the decedent’s gross estate receives a step-up. That share is determined by how much the decedent contributed to acquiring the property. If you and a sibling bought a rental house together and each paid half, only their half gets a new basis when they die. Your half keeps its original basis.

Assets That Don’t Qualify

Some inherited assets never receive a stepped-up basis because the income they represent was never taxed in the first place. These are classified as income in respect of a decedent, or IRD. The most common examples are traditional IRAs, 401(k) accounts, and deferred annuities. When heirs withdraw money from these accounts, they pay ordinary income tax at their personal rate, which for 2026 ranges from 10% to 37%.⁴ No step-up, no long-term capital gains rates. The full distribution is taxed as regular income.

Installment sale notes fall into the same IRD category. If the decedent sold property on an installment plan and was recognizing gain as payments came in, the remaining gain carries over to whoever inherits the note. The heir picks up the same percentage of gain on each payment that the decedent would have reported.⁸

Property given away during life also misses the step-up. Gifts carry a “carryover basis,” meaning the recipient keeps the donor’s original cost as their basis.² If your father bought stock for $10 a share and gives it to you when it’s worth $100, your basis is $10. Had he held it until death, you would have inherited it with a $100 basis instead. Lifetime gifts of highly appreciated property are one of the more expensive planning mistakes people make.

The One-Year Gift-Back Trap

Congress closed one obvious loophole. If someone gifts appreciated property to a person who then dies within one year, and the property passes back to the original donor (or the donor’s spouse), the step-up is denied. The donor’s basis remains whatever it was before the gift.¹ The property has to pass to someone other than the original donor for the step-up to work.

How Trusts Change the Answer

Whether trust assets get a step-up depends on the type of trust. Assets in a revocable living trust qualify because those assets remain part of the grantor’s gross estate at death. Revocable trusts are the most common estate planning vehicle, and for basis purposes they work the same as property owned outright.

Irrevocable trusts are a different story. When a grantor transfers property into an irrevocable trust, those assets generally leave the estate. Because the assets aren’t included in the gross estate at death, they don’t receive a stepped-up basis. The IRS confirmed this in Revenue Ruling 2023-2, holding that assets in an irrevocable grantor trust are not eligible for a basis adjustment under § 1014 when those assets aren’t part of the gross estate. The trade-off is inherent: you can remove assets from your estate to save on estate taxes, or you can keep them in your estate so heirs get the step-up, but you cannot have both.

The Community Property Double Step-Up

Married couples in community property states get one of the best deals in the tax code. When one spouse dies, both halves of community property receive a stepped-up basis, not just the decedent’s half. Federal law extends the basis adjustment to the surviving spouse’s share as long as at least half the community interest is included in the decedent’s gross estate. The IRS confirms this in Publication 555: the total fair market value of the community property generally becomes the basis of the entire property.⁹

The difference matters enormously. If a couple in a community property state bought a home for $200,000 and it’s worth $1,000,000 when one spouse dies, the surviving spouse’s entire basis resets to $1,000,000. They can sell immediately and owe zero capital gains tax. In a common law state under the same facts, only the decedent’s half would get a step-up. The survivor’s basis on their own half would remain $100,000, creating $400,000 of taxable gain on a sale.

Inherited Rental Property Wipes Out Depreciation Recapture

Rental property carries a hidden tax burden that the step-up washes away. Owners of rental property claim depreciation deductions each year, which reduce their basis. If they sell during life, that accumulated depreciation is “recaptured” and taxed at up to 25%. When rental property passes through an estate, the stepped-up basis eliminates all prior depreciation. The heir’s new basis is the full fair market value at death, with no depreciation recapture from the previous owner’s deductions.

The heir then starts a fresh depreciation schedule based on the new stepped-up value, which often generates larger annual deductions than the decedent was claiming. If the heir later sells, they owe depreciation recapture only on the deductions they personally took, not the accumulated deductions from before the inheritance. For families that have held rental property for decades and built up large depreciation recapture liabilities, this reset at death can save more in taxes than the step-up on the appreciation itself.

Documenting Fair Market Value at Death

Getting your basis right starts with documenting what the property was worth on the date of death. The IRS can challenge a claimed basis years later when you sell, and solid records matter far more than most heirs realize.

For real estate, a professional appraisal is the strongest evidence. For publicly traded securities, the value is the average of the highest and lowest trading prices on the date of death, and most brokerage firms will generate a date-of-death valuation report for an inherited account. Keep that report with your tax records permanently.

The Alternate Valuation Date

When estate values decline after death, the executor can elect to value assets as of six months after the date of death instead.¹⁰ The election has strict requirements: it must decrease both the total gross estate value and the estate tax liability. Estates below the filing threshold can’t use it, because there is no estate tax liability to reduce. Assets sold or distributed within the six-month window are valued as of the date of sale or distribution, not the six-month mark.

The alternate valuation date cuts two ways for heirs. It lowers the estate tax bill, but it also lowers the stepped-up basis, meaning higher capital gains taxes later.

Penalties for Overstating Basis

If you inflate your basis to reduce capital gains on a sale, the IRS can impose a 20% accuracy-related penalty on the underpayment. The penalty applies when the claimed basis is 150% or more of the correct amount.¹¹ A contemporaneous appraisal performed around the date of death is your best protection. An appraisal done years later, when you’re about to sell, carries far less weight with the IRS.

For estates large enough to file Form 706, an additional consistency rule applies: the basis you claim must match the value reported on the estate tax return, and the executor is required to send you a Schedule A showing that value.¹² If you inherit from an estate above $15,000,000, hold onto that Schedule A and use its values when you sell.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
3
Office of the Law Revision Counsel. 26 U.S. Code 1223 – Holding Period of Property
4
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
5
Internal Revenue Service. Net Investment Income Tax
6
Internal Revenue Service. Frequently Asked Questions on Estate Taxes
7
Internal Revenue Service. What’s New – Estate and Gift Tax
8
eCFR. 26 CFR 1.691(a)-5 – Installment Obligations Acquired From Decedent
9
Internal Revenue Service. Publication 555 – Community Property
10
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
11
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
12
eCFR. 26 CFR 1.6035-1 – Basis Information to Persons Acquiring Property From Decedent