Step-Up Basis: What It Is and How to Use It

Step-up in basis is one of the most valuable tax rules in the U.S. tax code — and one of the least understood by heirs. Used correctly, it can eliminate six figures of capital gains tax. Misunderstood, it costs you money you didn't have to spend.

What is step-up basis?

When you inherit an asset, your cost basis is "stepped up" to the fair market value (FMV) of that asset on the date of the owner's death — not what the original owner paid for it.¹ This is the IRC §1014 rule, and it applies to most inherited property: stocks, bonds, real estate, business interests, collectibles, and other capital assets.

The practical effect: decades of embedded capital gains are permanently erased at the moment of inheritance. If you sell the asset the day after inheriting it, your taxable gain is close to zero — because your starting basis is close to what you'd sell it for.

The math: what step-up basis actually saves

To quantify the tax impact, you need two numbers: the original cost basis and the FMV at the date of death. The difference is the "embedded gain" that the step-up eliminates.

Use the Step-Up Basis Calculator to enter your specific numbers and see the precise 2026 tax impact with and without the step-up.

Which assets get a step-up

IRC §1014 applies broadly to capital assets included in the decedent's gross estate. That includes:

• Stocks, bonds, and mutual funds held in taxable brokerage accounts
• Real estate — primary residences, rental properties, vacation homes, bare land
• Business interests — LLC/partnership membership interests, S-corp shares, sole proprietor goodwill
• Collectibles and tangible property — art, jewelry, coins, vehicles with appreciation
• Closely held stock in private companies (requires a qualified appraisal to establish FMV)

Which assets do NOT get a step-up — the common mistake

This is where heirs frequently make an expensive error. The following assets do not receive a step-up in basis:

• Traditional IRAs and 401(k)s — these are income in respect of a decedent (IRD). Distributions are fully taxable as ordinary income to you regardless of when you take them. There is no capital gain involved. The step-up doesn't apply.
• Roth IRAs and Roth 401(k)s — already tax-free. No basis issue. Step-up irrelevant.
• Annuities (non-qualified) — the embedded gain is IRD and taxable as ordinary income on distribution.
• U.S. savings bonds — accrued interest is IRD; taxable when redeemed, not stepped up.
• Assets held in certain irrevocable trusts — if the asset was in an irrevocable trust before death and not included in the gross estate, it generally does not receive a step-up.

Community property vs. common-law states

For married couples, the step-up rules vary significantly based on where you live:²

Community property states (AZ, CA, ID, LA, NM, NV, TX, WA, WI)

Under IRC §1014(b)(6), when a spouse dies, both halves of community property receive a step-up to FMV — including the surviving spouse's half. This is the "double step-up."

Example: Married couple in California bought stock for $100,000 in 2000. It's worth $900,000 when one spouse dies. The surviving spouse now holds $900,000 with a $900,000 basis — a $0 capital gain on any sale. In a common-law state with joint ownership, only half ($450,000 worth of basis) would step up.

Common-law states (all other states)

Only the deceased's share of jointly held property steps up. For a 50/50 joint tenancy (JTWROS), only the deceased's half gets a step-up. The survivor's half retains the original cost basis.

This difference can represent tens of thousands of dollars in additional capital gains tax. If you're in a community property state and recently widowed, confirm with your advisor before selling any appreciated joint assets — the full step-up may apply.

The immediate long-term gain benefit: IRC §1223(11)

Normally, you need to hold an asset for more than one year before gains qualify for the lower long-term capital gains rates. For inherited assets, that clock doesn't apply.³ Under IRC §1223(11), inherited property is automatically treated as long-term regardless of how long you hold it after inheriting — even if you sell it the day after.

This means you pay 0%, 15%, or 20% on any gain above the stepped-up basis — never the ordinary income rates of up to 37% that apply to short-term gains.

2026 long-term capital gains rates

Gains on inherited assets sold above the stepped-up basis are taxed at long-term rates. The 2026 thresholds (IRS Rev. Proc. 2025-32):⁴

The 3.8% Net Investment Income Tax (NIIT) applies on top of these rates for capital gains that push your modified AGI above $200,000 (single) or $250,000 (MFJ).⁵ The highest effective federal rate on capital gains is therefore 23.8% — before any state capital gains tax.

The 0% bracket opportunity: If your other income is low — a gap year, early retirement, a year with business losses — your taxable income may fall below the 0% threshold. In that case, selling inherited appreciated assets produces zero federal capital gains tax. This window is worth planning around deliberately if you have flexibility on when you sell.

Alternate valuation date: the 6-month option

If the inherited assets declined in value between the date of death and the time the estate was settled, the estate executor may elect to use the alternate valuation date (AVD) — FMV 6 months after death — instead of date-of-death FMV.⁶

The catch: AVD must be elected on the estate's federal estate tax return (Form 706), and it applies to all assets in the estate — you can't cherry-pick asset by asset. AVD also reduces the gross estate value, so it's only available (and only useful) when the estate is large enough to require Form 706. But for large estates that declined in value post-death, it can meaningfully increase your stepped-up basis.

If you're a beneficiary, you don't control this election — the executor does. Ask the executor (or estate attorney) whether AVD was considered if you inherited during a market downturn.

The deathbed gift trap: IRC §1014(e)

There's an anti-abuse rule built into the step-up law that heirs and estate planners must know.⁷ Under IRC §1014(e), if a decedent received appreciated property as a gift within one year before their death, and that property passes back to the original donor (or their spouse) through the estate, the step-up in basis is denied. The basis reverts to the donor's original cost basis.

Example: You give your mother $800,000 of highly appreciated stock you bought for $50,000. She dies within the year. The stock passes back to you through her estate. Under §1014(e), you do not receive a step-up — your basis remains your original $50,000.

This rule targets schemes where healthy individuals transfer appreciated assets to terminally ill family members specifically to get a step-up. The one-year lookback period applies to any gift returned to the donor, intentionally or not. Estate planning with terminally ill relatives requires careful coordination to avoid triggering §1014(e).

Step-up basis and real estate: depreciation recapture

For inherited rental or investment real estate, the step-up resets both the capital gains basis and the depreciation schedule. If the decedent had taken $200,000 of depreciation deductions on a rental property, that depreciation schedule is wiped clean at death — the heir starts fresh from the stepped-up value.

This eliminates not just the capital gain but also the depreciation recapture tax (which is taxed at a maximum 25% rate under Section 1250, not the 0%/15%/20% LTCG rates). For rental properties with decades of accumulated depreciation, this can represent a larger tax savings than the capital gain elimination itself.

See the Inherited Real Estate Guide for a full decision framework on sell vs. hold vs. rent.

Documenting FMV at date of death

The step-up only works if you can prove what the FMV was at the date of death. Documentation requirements vary by asset type:

• Publicly traded stocks: the average of the high and low price on the date of death (or the prior business day if death fell on a weekend or holiday). Brokerage custodians typically document this automatically.
• Real estate: a qualified appraisal by a licensed real property appraiser, dated as of the date of death. If no formal appraisal exists, you'll need a retroactive appraisal — possible but potentially contested by the IRS.
• Closely held business interests: a formal business valuation from a credentialed appraiser (ASA or CVA designation). This is often the most complex and disputed element of an estate.
• Collectibles and personal property: an appraisal from a qualified appraiser in the relevant field (art appraiser, jewelry appraiser, etc.).

If you sell within weeks of inheriting a public stock portfolio, there's virtually no gain to report anyway. But if you hold for months or years before selling, the date-of-death FMV becomes critical. Document it now while the information is fresh and accessible.

What a specialist advisor does differently

A generalist financial advisor understands step-up basis conceptually. A specialist who handles inheritance cases regularly thinks through:

• Which assets in the estate received a step-up and which didn't (IRD assets like IRAs look similar on paper but are treated completely differently)
• Whether community property rules apply and whether the double step-up was properly claimed
• Whether the alternate valuation date should have been elected — and if it was, what the stepped-up basis actually is on each asset
• How to sequence sales across multiple inherited asset types to minimize the NIIT exposure and stay in the 0% or 15% bracket
• Whether §1014(e) applies to any gifted-back assets in the estate
• How to coordinate step-up basis planning with state capital gains tax, which varies significantly
• For inherited real estate: whether a 1031 exchange makes sense to defer any remaining gain rather than selling directly

Related tools and guides

• Step-Up Basis Tax Savings Calculator — enter your numbers and see the exact federal tax with and without the step-up
• Inheriting a Brokerage Account — how to use the step-up to rebalance and diversify a concentrated inherited portfolio
• Inherited Real Estate: Sell, Rent, or Hold — step-up mechanics and depreciation recapture for inherited property
• Inherited IRA 10-Year Rule — the accounts that don't get a step-up, and how to minimize the tax impact
• What to Do When You Inherit Money — the full first-year playbook across all asset types