How Does the IRS Step-Up in Basis Work at the Death of a Spouse?

When your spouse dies, the assets you inherit generally get a new tax basis equal to their fair market value on the date of death, which can erase decades of built-up capital gains when you eventually sell. The step-up in basis at the death of a spouse works differently depending on where you live: in the nine community property states, the entire asset resets to current value, while in the 41 common law states only your deceased spouse’s half resets and your half keeps its original cost basis. That single distinction can move six figures of taxable gain on or off your future tax return.

How the Basis Reset Works

Every asset has a basis, usually what was paid for it plus improvements. When you sell, your taxable gain is the sale price minus that basis. Under IRC Section 1014, when someone dies most assets they owned reset to fair market value on the date of death.¹ A home bought for $150,000 and worth $750,000 at death has a new basis of $750,000 in the hands of the heir. Sell it the next day and the taxable gain is zero.

The adjustment runs both directions. If an asset lost value, the basis steps down to the lower fair market value, so heirs can’t claim a loss measured from the original purchase price.¹

The executor can value assets on the date of death or on an alternate date six months later. The alternate date is only available if the estate is required to file a federal estate tax return, and once elected the choice is irrevocable.² Choosing the later date can lower the estate tax bill if values fell, but it also produces a lower stepped-up basis for the surviving spouse.

Automatic Long-Term Treatment

Inherited property is automatically treated as held long-term, no matter how quickly you sell.³ Any gain qualifies for long-term capital gains rates rather than ordinary income rates, even on a sale the day after inheritance.

Depreciation Wipes Clean

For rental property and other depreciable assets, the step-up eliminates more than appreciation. Accumulated depreciation, which the IRS would otherwise recapture at rates up to 25 percent on sale, is also erased. The surviving spouse inherits the property at current fair market value with no recapture lurking underneath. On a rental owned and depreciated for 20 or 30 years, that alone can save tens of thousands.

Common Law States: Half the Property Resets

In the 41 common law states, married couples usually hold property as joint tenants with right of survivorship or as tenants by the entirety. Both automatically pass the deceased spouse’s interest to the survivor. For tax purposes, though, only the deceased spouse’s half is treated as part of their taxable estate, and only that half receives the stepped-up basis.⁴ Your own half keeps its original cost basis. Your new combined basis is the stepped-up half plus your original basis on the other half.

A couple in Virginia bought their home for $200,000, giving each spouse a $100,000 basis in their half. At the first death the home is worth $1,000,000. The decedent’s $500,000 half steps up to fair market value. The surviving spouse’s combined basis becomes $600,000: the $500,000 stepped-up half plus the surviving spouse’s original $100,000. A sale at $1,000,000 produces a $400,000 taxable gain, all attributable to the surviving spouse’s own half.

Community Property States: Both Halves Reset

Nine states use community property rules, and the benefit for surviving spouses is substantially larger. Under Section 1014(b)(6), when at least half of the community property is included in the deceased spouse’s estate, both halves receive a stepped-up basis.¹ The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

Run the Virginia example again in Texas. Same $200,000 original basis, same $1,000,000 value at death. The entire property steps up to $1,000,000. The surviving spouse could sell immediately with zero taxable gain. Compared to the common law result, that’s $400,000 of gain that never appears on the return. At a 15 percent long-term rate, roughly a $60,000 difference on identical facts.⁵

Several common law states let married couples opt in to community property treatment through special trusts. Alaska, South Dakota, Tennessee, Florida, and Kentucky have enacted such laws. The IRS has not issued guidance on whether assets in these opt-in community property trusts qualify for the full double step-up under Section 1014(b)(6), and Publication 555 explicitly declines to address federal treatment of property subject to these elective regimes.⁵ Couples relying on one of these trusts for the double step-up should work with a tax advisor who understands the unresolved area.

Combining the Step-Up With the Home Sale Exclusion

This is where surviving spouses often leave money on the table. A single filer can exclude up to $250,000 of gain on the sale of a primary home; a married couple filing jointly can exclude $500,000. After a spouse dies you might assume the survivor drops to $250,000 right away, but Section 121 provides a two-year window. If you sell within two years of your spouse’s death, have not remarried, and meet the ownership and use requirements, you can still claim the full $500,000 exclusion.⁶⁷

The two benefits stack. Take a couple in a common law state who bought their home for $200,000, worth $1,200,000 at the first death. The surviving spouse’s new basis is $700,000. A sale at $1,200,000 produces a $500,000 gain, and the $500,000 exclusion wipes it out entirely. Wait more than two years and the exclusion falls to $250,000, leaving $250,000 taxable. Once the window closes, that higher exclusion is gone for good.

What Does Not Get a Step-Up

Traditional IRAs and 401(k)s

Tax-deferred retirement accounts do not receive a stepped-up basis. The IRS treats the untaxed balance as income in respect of a decedent, meaning the tax obligation transfers to whoever receives the money.⁸ The surviving spouse or other beneficiary owes ordinary income tax on every dollar withdrawn.⁹ A surviving spouse who inherits $500,000 in appreciated stock can sell the next day and owe nothing in capital gains. A surviving spouse who inherits $500,000 in a traditional IRA will owe ordinary income tax on every distribution, at rates up to 37 percent.

The One-Year Gift Rule

Section 1014(e) blocks a specific maneuver: gifting appreciated property to a terminally ill person hoping it comes back with a stepped-up basis. If you give appreciated property to someone who dies within one year, and the property returns to you or your spouse, no step-up applies. The basis stays at whatever the decedent’s adjusted basis was immediately before death.¹ If the property passes to someone other than the original donor or the donor’s spouse, the normal step-up rules apply.

Capital Loss Carryovers

Unused capital loss carryovers generally die with the taxpayer. On the joint return for the year of death, the surviving spouse can apply the deceased spouse’s losses against gains earned that year. Once the tax year closes, any remaining carryover that belonged to the deceased spouse is gone permanently.⁴ Spouses with large unrealized losses may want to realize them during their lifetime rather than let them expire at death.

How Trusts Change the Answer

Assets in a revocable living trust receive a step-up just like assets owned outright, because the trust is included in the grantor’s taxable estate.

Qualified terminable interest property trusts, or QTIP trusts, receive a step-up at the second spouse’s death rather than the first. The surviving spouse gets income from the trust for life, and the trust assets are included in the surviving spouse’s gross estate at their death,¹⁰ which triggers a basis reset under Section 1014(b)(9).¹

Irrevocable grantor trusts are the surprise. In Revenue Ruling 2023-2, the IRS confirmed 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.¹¹ Grantor trust status for income tax purposes is not enough to trigger the reset. Estate inclusion is the key factor. If the trust was funded with a completed gift and the grantor kept no power to pull the assets back into the taxable estate, the basis after death is the same as the basis before, and beneficiaries face capital gains tax on the full appreciation when they sell.

Documenting the Fair Market Value

The step-up only helps if you can prove what the asset was worth on the date of death.

For publicly traded stocks and bonds, the IRS uses the average of the highest and lowest selling prices on the date of death. Most brokerage firms generate this figure automatically on estate-date valuation statements.

For real estate, get a professional appraisal from a qualified independent appraiser as close to the date of death as possible.¹² Reconstructing a value months or years later invites an IRS challenge, and a contemporaneous appraisal is the surviving spouse’s strongest defense on any future audit.

Privately held business interests require specialized valuation using methods like discounted cash flow or comparable transaction analysis, performed by qualified appraisers.¹³ For fine art and collectibles appraised at $50,000 or more, the IRS Art Appraisal Services division can issue an advance Statement of Value, effectively pre-approving the valuation before any dispute arises.¹⁴

Reporting the Step-Up and the Penalty for Getting It Wrong

The federal estate tax return, Form 706, is the primary documentation for stepped-up basis values. For 2026, estates must file Form 706 if the gross estate plus adjusted taxable gifts exceeds $15 million, or if the executor is electing portability of the unused estate tax exemption to the surviving spouse.¹⁵ Estates below the threshold sometimes file anyway to elect portability or to create an official record of asset values.

When Form 706 is required, the estate must also file Form 8971 and give each beneficiary a Schedule A listing the estate tax value of the assets received. This is due within 30 days of the Form 706 filing deadline or 30 days after the return is filed, whichever comes first.¹⁶ Those values are binding. When you later sell an inherited asset, your reported basis must be consistent with the value reported on the estate tax return.¹⁵ Estates that file solely to elect portability or make generation-skipping transfer tax elections are exempt from the Form 8971 reporting, as are estates whose gross value plus adjusted taxable gifts falls below the filing threshold.

Overstating a stepped-up basis to reduce capital gains carries real penalties. Under Section 6662, an inconsistent basis or substantial valuation misstatement triggers a 20 percent penalty on the resulting tax underpayment. If the claimed value is off by 200 percent or more, the penalty doubles to 40 percent.¹⁷ The surviving spouse bears the burden of proving the claimed basis is correct, which is why a contemporaneous appraisal or dated brokerage statement matters far more than a number reconstructed years later.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
3
Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property
4
Internal Revenue Service. Publication 559 (2025), Survivors, Executors, and Administrators
5
Internal Revenue Service. Publication 555 (12/2024), Community Property
6
Internal Revenue Service. Publication 523 (2025), Selling Your Home
7
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
8
Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
9
eCFR. 26 CFR Part 1 – Income in Respect of Decedents
10
eCFR. 26 CFR 20.2044-1 – Certain Property for Which Marital Deduction Was Previously Allowed
11
Internal Revenue Service. Internal Revenue Bulletin 2023-16
12
Internal Revenue Service. 4.48.6 Real Property Valuation Guidelines
13
Internal Revenue Service. 4.48.4 Business Valuation Guidelines
14
Internal Revenue Service. Art Appraisal Services
15
Internal Revenue Service. Instructions for Form 706 (Rev. September 2025)
16
Internal Revenue Service. Instructions for Form 8971 and Schedule A
17
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments