Stepped-Up Basis on Inherited Assets — Eliminate Capital Gains Tax on Appreciated Investments and Property
What Is It?
Under Internal Revenue Code § 1014, when you inherit an asset — stocks, mutual funds, real estate, or other appreciated property — your cost basis is “stepped up” to the fair market value on the date of the original owner’s death. Any capital gains that accumulated during the deceased person’s lifetime are permanently eliminated. You are not taxed on them, and they do not need to be reported.
This is one of the most powerful tax benefits in the U.S. tax code, and it is often missed by heirs who assume they owe tax on the full appreciation.
Example: A parent bought 500 shares of stock in 1990 for $10,000. At death, those shares are worth $200,000. If you inherit them, your basis is $200,000 — not $10,000. If you sell the day after inheriting, your capital gain is zero. The $190,000 of appreciation is gone from a tax perspective, permanently.
How the Stepped-Up Basis Works
The step-up is to fair market value on the date of death. For publicly traded securities, this is typically the average of the high and low trading prices on the date of death (not the closing price). For real estate, it is the appraised value.
Any gain from appreciation after the date of death is still taxable — only pre-death appreciation is wiped out. If you inherit stock worth $200,000 and it rises to $210,000 before you sell, you owe capital gains tax on the $10,000 post-inheritance appreciation.
Holding period: Inherited assets are automatically treated as long-term capital assets regardless of how long you or the decedent held them. Even if you sell the day after inheriting, the gain (if any) is taxed at the lower long-term capital gains rate (0%, 15%, or 20% depending on income).
What Qualifies
- Inherited assets from a deceased person’s estate (received via will, trust, beneficiary designation, or intestate succession)
- Stocks, bonds, mutual funds, ETFs
- Real estate (primary residence, rental property, vacant land)
- Business interests, partnerships
- Collectibles, art, precious metals
What Does NOT Qualify
- IRAs, 401(k)s, and other retirement accounts — these pass to heirs as ordinary income when withdrawn (no step-up applies; distributions are taxed in full)
- Assets you gifted to the deceased before death — if you gave an appreciated asset to someone who then died and you inherited it back within one year, no step-up applies
- Annuities — subject to ordinary income treatment on the gain portion
Community Property States: The Double Step-Up
In the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin), both spouses’ halves of a community property asset get a stepped-up basis when either spouse dies — not just the deceased spouse’s half.
Example: A married couple in California bought a rental property together for $300,000. At one spouse’s death, the property is worth $700,000. The entire $700,000 becomes the new basis — not just the deceased spouse’s 50% share. The surviving spouse can sell immediately with zero capital gains.
This double step-up does not apply in common-law (non-community property) states, where only the deceased spouse’s share receives a step-up.
Strategic Uses
“Hold until death” planning: For highly appreciated, non-income-producing assets (land, concentrated stock positions), holding rather than selling can eliminate the entire embedded gain if the asset passes through the estate.
Basis reset for heirs: If you are about to inherit an asset that has appreciated significantly, coordinate with the estate executor before any sale — selling before the step-up is applied is a permanent and costly mistake.
Establish the date-of-death value carefully: Hire a qualified appraiser for real estate and business interests. For securities, document the high/low trading prices on the date of death. The basis you establish now is what you will rely on when you eventually sell.
What Most People Don’t Know
- Executors and brokers don’t always automatically apply the step-up. Your brokerage may retain the original cost basis in its records unless you (or the estate) notify them of the inherited basis. Contact the brokerage, provide the date of death and the valuation, and request a cost basis update.
- Step-down is also mandatory. If an asset has declined in value since purchase, the basis is stepped down to fair market value at death — meaning selling immediately after inheriting a losing position results in no deductible loss. Consider whether it’s better to sell before the owner’s death if a loss exists.
- Revocable living trusts do get the step-up. Assets held in a revocable trust at the time of death are treated as if they were held directly by the decedent, so they receive the full step-up. Irrevocable trusts generally do not.
- Alternate valuation date. If an estate qualifies for an alternate valuation date election (6 months after death), all estate assets are valued at that later date instead. This can reduce estate tax but affects the step-up basis for all assets — the executor must weigh the trade-off.
- Congress has periodically proposed eliminating the step-up. The current law has been in place for decades but has faced proposed reforms. Monitor tax legislation if your estate planning relies on this strategy.
Legal Basis
- 26 U.S.C. § 1014 — Basis of property acquired from a decedent (the stepped-up basis rule)
- 26 U.S.C. § 1015 — Basis of property acquired by gift (by contrast, gifts do NOT receive a step-up)
- 26 U.S.C. § 1223(11) — Holding period for inherited property treated as long-term
- Treasury Regulation § 1.1014-1 through § 1.1014-8 — Detailed rules and exceptions
- IRS Publication 559 — Survivors, Executors, and Administrators
Frequently Asked Questions
How do I establish what the fair market value was on the date of death?
For publicly traded securities, use the average of the high and low prices on the date of death (found in historical stock data from any financial data provider). For real estate, a retroactive appraisal by a qualified appraiser establishing the date-of-death value is the standard. For other assets (business interests, collectibles), professional appraisals are required. Document everything in writing and keep it permanently with your tax records.
I inherited a house that was worth $500,000 at my parent’s death and I’ve rented it out for two years. What is my basis?
Your starting basis is $500,000 (the stepped-up value at death). If you have been depreciating the rental property, your current basis is $500,000 minus the depreciation you have claimed. When you sell, depreciation recapture tax (at 25%) applies to the depreciation taken, and any gain above your adjusted basis is taxed at long-term capital gains rates.
My parent’s estate includes IRAs and stocks. Which ones benefit from the step-up?
The stocks (held in a regular taxable brokerage account) receive the stepped-up basis. The IRAs do not — when you withdraw money from an inherited IRA, it is taxed as ordinary income in full, because the original contributions were made pre-tax. The step-up only applies to assets that were held outside of tax-deferred retirement accounts.
If I sell inherited stock immediately, do I owe any capital gains tax at all?
Likely no, or very little. If you sell the day you inherit (or shortly after), the sale price is essentially equal to your stepped-up basis (the fair market value at death). Any difference is the post-inheritance change in value, which is taxed at the favorable long-term capital gains rate. If the asset hasn’t moved since the date of death, your gain is zero.