A stepped-up basis is the reset that happens to the tax basis of property when its owner dies: the heir’s basis becomes the fair market value on the date of death rather than whatever the decedent originally paid. If a parent bought stock for $50,000 that was worth $400,000 the day they died, the heir’s basis is $400,000. Sell the next day at that price and the capital gains tax is zero. All the appreciation that built up during the decedent’s life vanishes from the tax ledger.
How the Reset Works
Tax basis is the number the IRS uses to figure gain or loss when you sell. Buy a rental for $200,000, sell for $350,000, and the gain is $150,000. During life, basis carries forward from what you paid, adjusted for improvements and depreciation.
Internal Revenue Code Section 1014 changes the math at death. The heir takes a basis equal to the property’s fair market value on the date the owner died.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The heir owes capital gains tax only on appreciation that occurs after the inheritance.
The dollars can be substantial. Federal long-term capital gains rates reach 20% for top earners, and the 3.8% Net Investment Income Tax can stack on top.2Internal Revenue Service. Questions and Answers on the Net Investment Income Tax On a $350,000 gain, a high-income heir could face roughly $83,000 in federal tax. A stepped-up basis can wipe that out entirely.
Setting the Value at Death
The new basis equals fair market value on the day the previous owner died. Fair market value is the price a willing buyer would pay a willing seller when neither is under pressure to act.3Internal Revenue Service. Gifts and Inheritances For publicly traded stock, that number is the closing price on the death date. For real estate, plan on a professional appraisal. The appraisal locks in the value for every future tax return, so cutting corners now can create problems years later when the property sells.
Estates that owe federal estate tax have a second option. The executor can elect to value everything six months after the date of death instead. This alternate valuation is available only if it reduces both the gross estate value and the total estate tax owed.4eCFR. 26 CFR 20.2032-1 – Alternate Valuation The election is made on the estate tax return and is irrevocable once the filing deadline passes. Estates that don’t owe estate tax can’t use it.
The trade-off matters. Using the alternate date to lower the estate tax also lowers the heir’s stepped-up basis. Saving $50,000 in estate tax by electing the alternate date can hand the heir a lower basis that generates more capital gains tax later. Executor and heir interests don’t always align on that call.
What Qualifies for a Step-Up
Most capital assets held in the decedent’s own name or in a revocable living trust receive the adjustment: real estate, individual stocks and bonds in taxable brokerage accounts, mutual funds, artwork and collectibles, business interests. The common thread is that value comes from capital appreciation.
Retirement accounts do not. Traditional IRAs, 401(k)s, and similar tax-deferred accounts hold money that was never taxed going in, and the IRS treats distributions as ordinary income to whoever receives them, whether the original owner during life or the heir after death. The tax code calls this income in respect of a decedent. An heir who inherits a $500,000 traditional IRA owes ordinary income tax (rates up to 37%) on every dollar withdrawn, with no basis offset. Inheriting a $500,000 brokerage account versus a $500,000 IRA can produce enormously different tax outcomes.
Roth IRAs are a partial exception. They technically don’t get a stepped-up basis either, but qualified distributions from an inherited Roth are already tax-free, so the question is mostly academic.
Why Gifts Before Death Are Different
Giving highly appreciated property away during life instead of letting it pass at death is one of the most expensive planning mistakes families make. A gift recipient doesn’t get a step-up. They inherit the giver’s original cost basis, sometimes decades old. The tax code calls this a carryover basis.5Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
The numbers can be stark. A parent who paid $80,000 for a rental now worth $500,000 could gift it to a child, who would take an $80,000 basis. Sell for $500,000, and the child owes tax on a $420,000 gain. Held until the parent’s death, the same property would have passed with a $500,000 basis and produced no tax on an immediate sale. That’s the difference between roughly $100,000 in federal tax and nothing.
There is a narrow case for gifting: estates large enough to owe federal estate tax (40%) where the property will keep appreciating. Removing it now shields future growth from estate tax. For families well below the exemption, holding appreciated assets until death is almost always better.
One anti-abuse rule is worth knowing. If you gift property to someone and they die within one year and leave it back to you, no step-up. The basis reverts to what it was before the gift. That prevents someone from parking appreciated assets with a dying relative solely to reset the basis.
Joint Ownership and Community Property
How the title is held determines how much of the asset resets. In most states, when one spouse dies and the couple held property as joint tenants with right of survivorship, only the deceased spouse’s half receives a step-up. The survivor keeps the original basis on their half. A home bought for $200,000 that’s worth $600,000 when one spouse dies produces a blended basis for the survivor: $100,000 on the original half plus $300,000 on the stepped-up half, or $400,000 total. A sale at $600,000 leaves a $200,000 taxable gain.
Community property states are more generous. When one spouse dies, the entire asset, including the surviving spouse’s half, resets to fair market value.6Internal Revenue Service. Publication 555 – Community Property Using the same numbers, the survivor’s basis becomes $600,000, and an immediate sale produces no gain. This double step-up is one of the biggest and most underappreciated tax advantages in community property jurisdictions. About nine states follow community property rules, and a few others let couples opt in through community property trusts.
Before selling anything, check the deed or account registration to confirm which structure applies. Getting it wrong means either overpaying or understating income.
Trusts: Which Ones Preserve the Step-Up
Revocable living trusts, the standard estate-planning trust most families use, preserve the step-up. Because the grantor kept control and the assets are included in the taxable estate, everything inside resets at death just as if it had been held directly.
Irrevocable grantor trusts are a different story, and the IRS drew a firm line in 2023. Revenue Ruling 2023-2 established that assets in an irrevocable grantor trust do not receive a stepped-up basis at the grantor’s death if those assets aren’t included in the grantor’s gross estate for estate tax purposes.7Internal Revenue Service. Internal Revenue Bulletin 2023-16 – Revenue Ruling 2023-2 The logic: Section 1014 applies to property “acquired from a decedent,” and if the assets were removed from the estate through a completed gift to the trust, they don’t qualify.
That ruling upended a strategy many planners had used for years. The assumption had been that because the grantor was treated as the owner for income tax purposes, death would trigger a basis reset. The IRS said no. Estate tax treatment controls, and out-of-estate means no step-up. Anyone with an existing irrevocable grantor trust should review the basis consequences with an advisor.
When the Basis Goes Down
The adjustment cuts both ways. If an asset lost value during the decedent’s life, the basis resets downward. A parent who paid $100,000 for stock worth $40,000 at death leaves the heir with a $40,000 basis. The $60,000 loss that accrued during the parent’s lifetime is gone, and nobody deducts it.
That’s why it can make sense for an aging owner to sell depreciated assets before death, claim the capital loss on their own return, and pass the cash. The loss is worth something on the owner’s return; hold the asset until death and the loss vanishes. If an heir later sells inherited property for less than the stepped-down basis, they can claim that further loss, but only on the decline after the date of death.3Internal Revenue Service. Gifts and Inheritances
Documenting the Basis and Reporting It
Claiming a stepped-up basis isn’t free. Heirs often need a professional appraisal to establish the date-of-death value, especially for real estate. Residential appraisals for estate purposes typically run several hundred dollars, though complex or retrospective valuations cost more. Business valuations usually run several thousand for a formal report from a credentialed appraiser. An undocumented basis is an indefensible basis, and appraisal costs are trivial next to the tax at stake on a major asset.
When an estate is large enough to require a federal estate tax return (Form 706), the executor also has to report basis information to the IRS and to the heirs. Form 8971, with a Schedule A for each beneficiary, is the vehicle.8Internal Revenue Service. About Form 8971 – Information Regarding Beneficiaries Acquiring Property From a Decedent The filing deadline is 30 days after the earlier of the date the estate tax return is due (including extensions) or the date the return is actually filed.9Internal Revenue Service. Instructions for Form 8971 and Schedule A Missing the deadline can trigger penalties under Sections 6721 and 6722 even when the estate owes no tax, and the penalties apply separately for failing to file with the IRS and for failing to furnish the schedule to beneficiaries.
The consequence for heirs is a consistency requirement: once the estate reports a value on Form 8971, the heir must use that same value as their basis when they sell. Commissioning a separate appraisal and picking a more favorable number invites an IRS inquiry.
With the federal estate tax exemption dropping to roughly $7 million per person in 2026 (down from about $14 million in 2025) after the Tax Cuts and Jobs Act’s doubled exemption expires, significantly more estates will need to file Form 706 and, along with it, Form 8971. Families that never had to think about estate reporting may hit these requirements for the first time.
Penalties for Overstating a Basis
Inflating a stepped-up basis to shrink a later capital gain carries real exposure. Under Section 6662, claiming a basis 150% or more of the correct amount triggers an accuracy-related penalty of 20% of the resulting underpayment.10Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments Overstate by 200% or more, and the penalty doubles to 40%. Those penalties sit on top of the additional tax owed. The best protection is a qualified appraisal performed close to the date of death, with documentation that matches what the estate reported.