Property you inherit generally receives a stepped-up basis at death equal to the asset’s fair market value on the date the owner died. That reset, set out in Internal Revenue Code Section 1014, can erase decades of built-in appreciation in a single moment. Sell the asset shortly after inheriting it and your capital gains tax is often zero.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The rule applies whether or not the estate owes any federal estate tax, and it covers most capital assets. Retirement accounts and a few other categories are the notable exceptions.
How the Reset Works in Practice
Every asset has a tax basis. It usually starts as the purchase price and shifts over time for improvements (up) or depreciation (down). When you sell, your capital gain is the sale price minus that adjusted basis.
At death, the tax code throws out the decedent’s basis and gives the heir a new one: fair market value on the date of death. If your father bought stock for $10,000 forty years ago and it was worth $500,000 the day he died, your basis is $500,000. Sell it the next week at that price and you owe nothing on the gain.
The adjustment runs both ways, which people forget. If the asset lost value during the decedent’s ownership, the basis steps down to the lower date-of-death figure. A property your mother bought for $500,000 that was worth $400,000 when she died gives you a $400,000 basis. Sell for $450,000 and you have a $50,000 gain, even though the property lost money overall. Any built-in loss the decedent could have claimed disappears at death.
Most estates never come near the federal estate tax exemption, but every heir still gets the basis adjustment. An $800,000 estate and an $80 million estate operate under the same Section 1014 rule.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
The Holding Period Is Automatically Long-Term
Capital gains rates depend on how long you held the asset. Property held a year or less is taxed at ordinary income rates. Longer than a year and it qualifies for the long-term rates of 0%, 15%, or 20%.2Internal Revenue Service. Topic No. 409, Capital Gains and Losses
Inherited assets get a bonus rule. Under Section 1223(9), any property that receives a stepped-up basis is treated as held for more than one year, even if you sell it the day after inheriting it.3Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property Short-term treatment never applies to an inherited asset. Any gain above your new basis lands in long-term territory automatically.
Which Assets Get the Step-Up
The rule reaches most capital assets the decedent owned at death:
- Publicly traded stocks, bonds, mutual funds, and ETFs.
- Real estate of every kind, including a primary home, vacation home, rental, commercial building, or undeveloped land.
- Personal property such as jewelry, artwork, antiques, and collectibles.
- Business interests, including sole proprietorships, partnerships, LLCs, and closely held corporations. The step-up passes through to the underlying business assets.
One detail catches heirs off guard. If you inherit real estate with a mortgage still on it, your basis is the property’s full fair market value, not the value minus the loan balance. A home worth $600,000 with a $200,000 mortgage gives you a $600,000 basis. The mortgage is the estate’s liability; it doesn’t reduce what you got for tax purposes.
What Doesn’t Get a Step-Up: Retirement Accounts and Other IRD
Some assets are carved out because they represent money the decedent earned but never paid income tax on. The tax code calls this “Income in Respect of a Decedent,” or IRD. The heir steps into the decedent’s tax position and owes income tax on the money when it’s collected.4IRS. Revenue Ruling 2005-30, Part I Section 691 – Recipients of Income in Respect of Decedents
Traditional IRAs and 401(k) plans are the biggest examples. Every dollar you pull from an inherited traditional IRA is ordinary income to you, just as it would have been to the original owner. Other IRD includes unpaid wages, deferred compensation, and payments still owed under an installment sale.
The planning consequence is substantial. A $500,000 brokerage account and a $500,000 traditional IRA look identical on paper. The brokerage account can pass to an heir with essentially no capital gains tax; the IRA is taxed dollar-for-dollar as it’s withdrawn.
Setting the Date-of-Death Value
The step-up only helps if you can establish a defensible value. The method depends on the asset.
Stocks, Bonds, and Funds
For anything traded on a public exchange, fair market value is the average of the high and low trading prices on the date of death. If the person died on a weekend or holiday, average the values from the nearest trading days before and after.
Real Estate, Business Interests, and Collectibles
Real estate, closely held business interests, artwork, and similar assets call for a formal appraisal from a qualified professional. The IRS expects the appraiser to have verifiable education and experience valuing that type of property, either through professional coursework plus at least two years of experience or through a recognized appraiser designation.5eCFR. 26 CFR 1.170A-17 – Qualified Appraisal and Qualified Appraiser The appraiser cannot be the beneficiary, the executor, or anyone whose fee depends on the value they come up with.
For closely held business interests, appraisers often apply valuation discounts. A minority stake with no management control is worth less than its proportional share of the company, and an interest in a private company that can’t be freely sold is worth less than an equivalent public-company interest. Those discounts reduce the stepped-up basis, which cuts both ways: a lower basis today means more taxable gain if you later sell at a higher price.
Jointly Owned Property
How much of a co-owned asset gets a step-up depends on who the co-owners are and the state where the property sits.
Married Couples Outside Community Property States
When spouses own property as joint tenants with right of survivorship or as tenants by the entirety, each spouse is treated as owning exactly half, regardless of who paid.6Office of the Law Revision Counsel. 26 USC 2040 – Joint Interests When one spouse dies, the decedent’s half steps up to fair market value; the surviving spouse’s half keeps its original basis. Net result: 50% step-up.
Community Property States
Married couples in community property states get a better outcome. When one spouse dies, both halves of the community property receive a step-up.7Internal Revenue Service. Publication 555 (12/2024), Community Property The surviving spouse’s half gets a new basis too, so 100% of the accumulated appreciation disappears. The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. For couples with large unrealized gains, the double step-up can save hundreds of thousands of dollars.
Non-Spousal Joint Owners
Different rule for joint tenants who aren’t married to each other, such as siblings on a vacation home or a parent and adult child on a bank account. Under Section 2040(a), the entire value is presumed to belong to the decedent’s estate unless the surviving tenant can prove they contributed their own money to the purchase.6Office of the Law Revision Counsel. 26 USC 2040 – Joint Interests Whatever portion ends up in the decedent’s estate is what gets the step-up. If the survivor paid nothing, the full value can be included and stepped up. If the survivor paid half, only the decedent’s half gets stepped up. Keep records of contributions; without them, the presumption controls.
Trust Assets
Whether trust assets get a step-up comes down to whether they’re included in the grantor’s taxable estate at death.
Assets in a revocable living trust do get the step-up. Because the grantor kept the power to change or cancel the trust, the assets are included in the gross estate under Section 2038.8Office of the Law Revision Counsel. 26 USC 2038 – Revocable Transfers For tax purposes the grantor still owned everything, and it steps up the same way it would if held in the decedent’s own name.
Assets in an irrevocable trust usually don’t get a step-up, because the grantor gave up control and the assets are outside the taxable estate. Exceptions exist. Some irrevocable trusts are intentionally structured so that the assets remain in the gross estate, through retained powers or interests that trigger inclusion under various estate tax provisions. Whether a particular irrevocable trust qualifies is almost always a question for professional analysis of the trust document.
The One-Year Gift-Back Rule
Section 1014(e) closes an obvious loophole: gifting appreciated property to a dying person so it bounces back with a fresh basis. If the decedent received appreciated property as a gift within one year of death, and that property passes back to the original donor or the donor’s spouse, the step-up does not apply.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The donor’s basis instead is the decedent’s adjusted basis right before death, which is typically what the donor started with. The round trip accomplishes nothing.
The rule only triggers on a return to the donor or the donor’s spouse. If the decedent leaves the gifted asset to a different beneficiary, the normal step-up applies.
Reporting and the Consistency Rule
For most heirs there’s no separate IRS filing to establish basis; the date-of-death fair market value simply becomes your basis, and you use it when you eventually sell.
Larger estates work differently. Executors of estates required to file a federal estate tax return (Form 706) must also file Form 8971 and give each beneficiary a Schedule A reporting the final value of the property they inherited. That Schedule A establishes the stepped-up basis for the beneficiary’s future returns. The deadline is 30 days after the earlier of the date Form 706 is due (with extensions) or the date it’s actually filed.9Internal Revenue Service. Instructions for Form 8971 and Schedule A (Rev. August 2025)
Here’s the part heirs need to know. If you inherit property reported on Schedule A and later report a higher basis on your own return when you sell, you face a 20% accuracy-related penalty on any resulting underpayment.10eCFR. 26 CFR 1.6662-9 – Inconsistent Estate Basis Reporting Your basis for income tax purposes cannot exceed what the estate reported. If you think the estate undervalued something, raise it during estate administration, not years later when you sell.
Form 8971 isn’t required when the gross estate plus adjusted taxable gifts falls below the basic exclusion amount, or when Form 706 is filed only to elect portability or make generation-skipping transfer tax elections.9Internal Revenue Service. Instructions for Form 8971 and Schedule A (Rev. August 2025) For estates below the threshold, no formal basis reporting is required. You document the date-of-death value yourself (appraisal, brokerage statement, or trading data) and hold onto it for when you sell.
State Taxes Are a Separate Question
About 18 states impose their own estate tax, inheritance tax, or both, sometimes with exemptions far below the federal figure. Massachusetts starts taxing estates above $1 million, Oregon above $2 million, and several states impose inheritance taxes on beneficiaries based on their relationship to the decedent. None of that changes whether you receive a federal stepped-up basis, but it can affect what actually reaches you. Worth checking your state’s rules, especially if the decedent owned property in more than one state.