IRS Section 1014: Step-Up in Basis Rules for Inherited Assets

When you inherit property, Section 1014 of the Internal Revenue Code resets your tax basis to the asset’s fair market value on the date the previous owner died. This step-up in basis on inherited assets wipes out the capital gain that built up during the decedent’s lifetime, so if you sell soon after inheriting, you may owe little or no capital gains tax. The reset works in both directions: if the asset lost value before death, your basis steps down to the lower figure.¹

How the Reset Actually Works

Every asset carries a tax basis, which is essentially its cost for tax purposes. A stock bought for $20,000 has a $20,000 basis; a house bought for $150,000 has a $150,000 basis. Sell later, and gain or loss is measured against that figure.

Section 1014 replaces the decedent’s original cost with the asset’s fair market value on the date of death. If your parent bought stock for $10,000 and it was worth $200,000 when they died, your basis is $200,000. The $190,000 of appreciation is never taxed as income. Sell the next day at $200,000 and your taxable gain is zero.¹

The reverse hurts. If your parent paid $100,000 for stock worth $40,000 at death, your basis steps down to $40,000. The $60,000 of built-in loss is gone; nobody gets to claim it.

Which Assets Qualify

The step-up applies to property included in the decedent’s gross estate for federal estate tax purposes. That covers most of what people own: real estate (including foreign real estate), stocks, bonds, mutual funds and ETFs, business interests, and tangible personal property like jewelry, vehicles, art, and collectibles.

The big exception is “income in respect of a decedent,” or IRD. These are assets that represent income the decedent earned but never reported. Giving them a step-up would let that income permanently escape tax, so the code doesn’t allow it.¹ The common IRD categories:

Traditional IRAs and 401(k) accounts. Contributions were pretax; withdrawals remain taxable as ordinary income to the beneficiary.
Annuities. The tax-deferred growth portion is taxed as ordinary income when distributed.
Installment sale receivables. Remaining payments keep their built-in gain.
Unpaid compensation and deferred bonuses the decedent had earned but not yet received.

If your inheritance is a traditional retirement account, don’t expect a basis reset. You’ll owe income tax on distributions the same way the decedent would have.

Setting the Fair Market Value

The default rule uses fair market value on the exact date of death. For publicly traded securities, that’s typically the average of the day’s high and low quoted prices.² Real estate requires a formal appraisal from a qualified appraiser as of the date of death. Keep that appraisal permanently; it’s your evidence if the IRS ever questions the basis you claim. Unique assets such as artwork, antiques, or closely held business interests need specialized appraisals.

The executor of the estate has a second option: elect the alternate valuation date, which values everything six months after death. The election is only available if it reduces both the gross estate and the estate tax liability, it’s made on Form 706, and once made it’s irrevocable. Any asset sold or distributed inside the six-month window is valued as of the date it left the estate.³

For heirs, this election has a downside. The alternate date generally reflects lower values (that’s the point for estate tax purposes), which means your stepped-up basis will also be lower. Estate tax savings for the estate can translate into higher capital gains tax for you when you eventually sell.

How Ownership Structure Changes the Math for Spouses

The way property was titled makes an enormous difference when a spouse dies.

Community Property States

In community property states, both halves of community property receive a step-up when either spouse dies, including the surviving spouse’s half.² A couple who bought a home for $200,000 now worth $800,000: the surviving spouse’s new basis in the entire property is $800,000. All $600,000 of appreciation disappears.

The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. At least half the community interest must be includible in the decedent’s gross estate for this double step-up to apply.

Joint Tenancy in Other States

In common-law states, joint tenancy and tenancy by the entirety produce only a half step-up. The decedent’s share resets to fair market value; the survivor’s share keeps its original basis.²

Same $200,000 home now worth $800,000: the surviving spouse’s basis becomes $500,000 (the $100,000 original basis on their half plus the $400,000 stepped-up basis on the decedent’s half). Selling produces $300,000 of taxable gain instead of zero.

Property Held in Trust

Whether trust assets get a step-up depends on whether they end up in the decedent’s gross estate.

Assets in a revocable living trust do qualify. During the grantor’s lifetime the trust is disregarded for tax purposes; when the grantor dies the assets are included in the gross estate, and beneficiaries get the same basis reset they’d get from a direct bequest.

Irrevocable grantor trusts are different. In Revenue Ruling 2023-2, the IRS confirmed that assets in an irrevocable grantor trust do not receive a step-up if they aren’t included in the grantor’s gross estate.⁴ That affects grantor retained annuity trusts, qualified personal residence trusts, insurance trusts, and similar structures. Some irrevocable trusts are deliberately drafted so their assets are pulled into the gross estate through retained powers, and in those cases the step-up applies. The trade-off is estate tax exposure against income tax savings, a calculation that shifts with the federal estate tax exemption of $15,000,000 for 2026.⁵

The One-Year Gift-Back Rule

Section 1014(e) blocks an obvious workaround: gifting appreciated property to a dying relative, then inheriting it back with a stepped-up basis. If you give appreciated property to someone, they die within one year, and the property passes back to you or your spouse, you don’t get a step-up. Your basis stays what it was before the gift.¹

The rule only strips the step-up when the property returns to the original donor or the donor’s spouse. If it goes to someone else, or if the decedent lives more than a year after receiving the gift, the normal step-up applies.

What You’ll Owe When You Sell

Once you have your basis, the tax on a sale is straightforward: sale price minus stepped-up basis equals taxable gain. Basis of $400,000, sale at $410,000, taxable gain of $10,000.

Inherited property automatically qualifies for long-term capital gains treatment, no matter how briefly you hold it. Even a sale the day after inheriting gets long-term rates.⁶

For 2026, the long-term capital gains brackets are:

0% on taxable income up to $49,450 single or $98,900 married filing jointly.
15% from those thresholds up to $545,500 single or $613,700 married filing jointly.
20% above $545,500 single or $613,700 married filing jointly.

Higher earners may also owe the 3.8% net investment income tax on capital gains when modified adjusted gross income exceeds $200,000 single or $250,000 married filing jointly, bringing the top federal rate on long-term gains to 23.8%.⁷

Reporting and the Consistent Basis Rule

For estates large enough to require Form 706 (generally those with gross assets over $15,000,000 for decedents dying in 2026), the executor must also file Form 8971 and issue each beneficiary a Schedule A listing the reported value of the property they received. Form 8971 is due within 30 days of the earlier of Form 706’s due date or its actual filing.⁸

Under Section 1014(f), if the inherited property increased the estate’s tax liability, your basis cannot exceed the value shown on Schedule A. Reporting a higher basis at sale triggers a 20% accuracy-related penalty on any resulting underpayment.⁹

Estates below the Form 706 filing threshold don’t trigger Schedule A. Your basis is still the date-of-death fair market value, but you’ll need your own documentation, typically an appraisal for real estate or brokerage statements for securities, to defend the figure you use.

Why Inheritance Beats a Lifetime Gift for Appreciated Property

Lifetime gifts follow a different rule. Under Section 1015, gifted property carries the donor’s original basis over to the recipient.¹⁰ Receive stock a parent bought for $5,000 that’s now worth $150,000, and your basis is $5,000. Sell it and you owe capital gains tax on $145,000. Inherit the same stock and your basis becomes $150,000.

The planning consequence is direct: highly appreciated assets are generally better held in the estate than gifted during life. Depreciated assets go the other way. If a parent sells a loss position themselves before death, they can claim the loss; if the same asset passes through the estate, the step-down destroys it and nobody deducts it.²

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
Internal Revenue Service. Publication 551 – Basis of Assets
3
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
4
Internal Revenue Service. Internal Revenue Bulletin 2023-16 – Revenue Ruling 2023-2
5
Internal Revenue Service. What’s New – Estate and Gift Tax
6
Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property
7
Internal Revenue Service. Net Investment Income Tax
8
Internal Revenue Service. Instructions for Form 8971
9
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty
10
Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust