When you inherit property, your tax basis is generally the property’s fair market value on the date the previous owner died, not what they originally paid. This step-up in basis for inherited property wipes out the gain that accumulated during the decedent’s lifetime, so if you sell soon after inheriting, you often owe little or no capital gains tax. The rule comes from 26 USC 1014, and it applies to most inherited assets with a handful of important exceptions.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
How Your Basis Is Set
Section 1014(a) sets the default rule: property acquired from a decedent takes a basis equal to its fair market value on the date of death. The point is to line up your basis with the value used for federal estate tax purposes.2eCFR. 26 CFR 1.1014-1 – Basis of Property Acquired From a Decedent Say your grandmother bought stock for $20,000 decades ago and it was worth $200,000 the day she died. Your basis is $200,000. Sell it the following week for $201,000, and you have a $1,000 gain rather than a $180,000 gain.
The adjustment works in the other direction too. If the fair market value at death is lower than what the decedent originally paid, your basis steps down. You inherit a loss position, and selling at that value produces no deductible loss. This matters most with depreciating assets or real estate bought at a market peak.
For estates large enough to require a federal estate tax return, the value reported on Form 706 fixes your basis. Estates must report the value of every asset in the gross estate, and beneficiaries must use a basis consistent with that reported value.3Internal Revenue Service. Instructions for Form 706 (Rev. September 2025) For estates below the filing threshold ($15,000,000 for deaths in 2026), no Form 706 is required, and heirs establish basis through appraisals and other valuation evidence.4Internal Revenue Service. Whats New – Estate and Gift Tax
The Alternate Valuation Date
Under Section 2032, the executor can elect to value the entire estate six months after the date of death instead of on the date of death itself.5Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation Any property sold or distributed during that six-month window gets valued as of the disposition date. The election is all-or-nothing across the estate and is only available when it reduces both the estate value and the estate tax owed.
This affects heirs directly because the alternate date becomes your basis. If markets dropped in the six months after death, the alternate valuation could leave you with a lower basis than the date-of-death value, and a larger taxable gain when you sell. The executor’s decision is irrevocable once made.
Assets That Don’t Get a Step-Up
Not everything you inherit resets. Section 1014(c) excludes any asset that represents a right to receive “income in respect of a decedent” under Section 691. These are items the decedent had earned or was entitled to but had not yet been taxed on before dying. The income tax obligation passes through to whoever receives the asset. The common examples:
- Traditional IRAs and 401(k)s. The decedent never paid income tax on these funds. When you take distributions, you pay ordinary income tax just as the decedent would have.
- Annuity contracts. Section 1014(b)(9)(A) specifically carves out annuities described in Section 72 from the basis step-up.
- Accrued but unpaid income, including wages earned before death, uncashed dividend checks, and similar items.
- Installment sale receivables. Remaining gain built into installment payments does not get a step-up.
The regulations confirm that Section 1014(a) does not apply to any of these amounts in the hands of the estate or the beneficiary.6eCFR. 26 CFR Part 1 – Income in Respect of Decedents If you inherit a sizable traditional IRA, plan for the income tax. The estate does get a deduction under Section 691(c) for any estate tax attributable to those items, which partially offsets the double taxation but does not eliminate the income tax.
Valuing What You Inherited
Fair market value sounds simple, but the method varies by asset type, and the wrong number produces the wrong basis and the wrong tax when you sell.
Publicly Traded Securities
For stocks and bonds with an active market, the IRS defines fair market value as the average of the highest and lowest selling prices on the date of death.7eCFR. 26 CFR 20.2031-2 – Valuation of Stocks and Bonds If no trades occurred that day, you take a weighted average of the mean prices on the nearest trading days before and after death, weighted inversely by the number of days between each trading date and the date of death. A brokerage statement showing the closing price is close but technically not the correct figure.
Real Estate and Other Property
Real estate, closely held businesses, artwork, and other assets without a ready market price require professional appraisals. The IRS expects a qualified appraisal reflecting market conditions on the exact date of death. If no estate tax return is filed, heirs should still obtain an appraisal to document basis in case of a future audit. A few hundred dollars for a residential appraisal is cheap insurance against an unsupported basis claim.
Community Property Gets a Double Step-Up
Community property states offer a major advantage. When one spouse dies, both halves of community property receive a stepped-up basis, not just the decedent’s half. Section 1014(b)(6) provides that the surviving spouse’s share qualifies for the basis adjustment as long as at least half of the community interest was includible in the decedent’s gross estate.
The practical difference is large. Say a married couple bought a home as community property for $200,000, and it is worth $800,000 when one spouse dies. In a community property state, the survivor’s new basis for the entire property is $800,000. In a common law state holding the same home as joint tenants, only the decedent’s half gets stepped up, leaving a basis of $500,000 ($100,000 original half plus $400,000 stepped-up half). Sell at $800,000 and the community property state produces zero gain; the common law state produces a $300,000 gain.
The full step-up only works if the property actually qualifies as community property. Revocable living trusts generally preserve community property character, but irrevocable trusts can convert assets into separate property and disqualify them. Couples who move from a common law state to a community property state should know that property acquired before the move is generally treated as “quasi-community property,” which the IRS does not treat as community property for income tax purposes.8Internal Revenue Service. 25.18.1 Basic Principles of Community Property Law
Joint Ownership Outside Community Property
In a joint tenancy with right of survivorship, the decedent’s share passes to the surviving owner and only that share receives a step-up. If two siblings own property as equal joint tenants and one dies, the survivor’s new basis is their original basis in their half plus the stepped-up value of the decedent’s half.
Figuring out the decedent’s share gets tricky when ownership percentages don’t match financial contributions. If a parent added an adult child to a property title for convenience but the child never paid anything, the IRS may treat the entire property as belonging to the parent’s estate. That actually benefits the child: the full property gets a step-up. If the child contributed 30% of the purchase price, only the parent’s 70% gets the step-up while the child keeps their original basis in their 30%.
For married couples in common law states who hold property as joint tenants or tenants by the entirety, only the decedent’s half gets a new basis. That is a real disadvantage compared with couples in community property states.
The One-Year Rule for Gifted Property
Section 1014(e) closes what would otherwise be an obvious loophole. Picture this: you own stock with a very low basis and large unrealized gain. You gift it to an elderly or terminally ill relative. When that person dies shortly after, the stock passes back to you with a stepped-up basis, erasing the gain without anyone paying tax on it.
The statute blocks this. If appreciated property was gifted to the decedent within one year of death and comes back to the original donor or the donor’s spouse, the basis is not stepped up. It stays equal to the decedent’s adjusted basis immediately before death, which is the same low basis the donor started with. The rule also applies if the estate sells the property and the donor receives the proceeds. If the property instead passes to a different beneficiary, the normal step-up applies.
Inherited Rental and Depreciable Property
When you inherit income-producing property like a rental building, the stepped-up basis becomes your new starting point for depreciation. Whatever depreciation the decedent claimed is irrelevant. You begin a fresh schedule using the fair market value at death, allocated between land (not depreciable) and improvements.
You also do not owe depreciation recapture on the deductions the decedent took. Both Section 1245 and Section 1250 contain explicit exceptions for transfers at death.9Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property10Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty The decedent’s prior deductions effectively disappear from the tax system. Inheriting a fully depreciated rental building is particularly valuable: you get a fresh basis to depreciate all over again, and no one pays tax on the old deductions.
Reporting Your Basis: Consistency and Form 8971
When an estate files Form 706, the law requires beneficiaries to use a basis consistent with the value reported on that return. You cannot claim a low value on the estate return to reduce estate tax and then a higher basis on your own return to reduce capital gains tax. The executor must file Form 8971 and furnish Schedule A to each beneficiary, reporting the estate tax value of the assets they received.11Internal Revenue Service. Instructions for Form 8971 and Schedule A
Form 8971 is due 30 days after the earlier of the Form 706 due date (including extensions) or the actual filing date, and beneficiaries must receive their Schedule A by the same deadline. The requirement applies only when an estate tax return is required, so estates below the $15,000,000 basic exclusion amount for 2026 deaths are generally exempt.
If you report a basis that exceeds the value determined for estate tax purposes, you face a 20% accuracy-related penalty on any resulting underpayment of income tax.12eCFR. 26 CFR 1.6662-9 – Inconsistent Estate Basis Reporting
Calculating Gain or Loss When You Sell
Once your stepped-up basis is set, gain or loss equals sale price minus basis, adjusted for any capital improvements you made after inheriting and any depreciation you claimed.
One detail surprises many heirs: inherited property is automatically treated as held for more than one year, even if you sell the day after the decedent died. Section 1223(9) treats any property with a basis determined under Section 1014 as long-term for capital gains purposes.13Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property You qualify for long-term rates (0%, 15%, or 20%, depending on your income) no matter how quickly you sell.
If the property dropped in value since the decedent’s death and you sell at a loss, the tax treatment depends on how the property was used. Losses on investment or rental property are deductible. They offset other capital gains dollar for dollar, and if your capital losses exceed your gains for the year, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately), with any remainder carrying forward.14Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses Losses on personal-use property, like an inherited home you moved into, are not deductible.
Capital improvements you make before selling increase your basis. A new roof, an addition, or similar upgrades reduce the taxable gain. Routine maintenance and repairs don’t count. Keep receipts and contractor invoices alongside the appraisal that established your stepped-up basis, because the IRS can ask to see all of it.
If You Live Outside the United States
Section 1014’s step-up applies regardless of the beneficiary’s citizenship or residence, so a nonresident who inherits U.S. property gets the same basis adjustment. The estate tax picture is different, though. For a nonresident, non-citizen decedent, the estate tax filing threshold on U.S.-situated assets is only $60,000, compared with $15,000,000 for U.S. citizens and residents in 2026.15Internal Revenue Service. Some Nonresidents With U.S. Assets Must File Estate Tax Returns
When a nonresident later sells inherited U.S. real estate, the buyer must withhold 15% of the amount realized under the Foreign Investment in Real Property Tax Act.16Internal Revenue Service. FIRPTA Withholding Because the withholding applies to the full sale amount rather than just the gain, it often exceeds the actual tax owed. You recover the difference by filing Form 1040-NR, or you can apply for a withholding certificate before closing to reduce the amount withheld.