Step-Up in Basis for Inherited Property: Rules and Exceptions

When you inherit property, its tax cost resets to what the asset was worth on the date the previous owner died. That reset is the step-up in basis for inherited property, and it can erase decades of built-in capital gain in a single moment. If your parent bought stock for $5,000 thirty years ago and it was worth $200,000 the day they died, your basis becomes $200,000. Sell it the next week for that amount and you owe nothing on the $195,000 of appreciation.¹ Getting the valuation right, and keeping the paperwork that proves it, is the single most important thing an heir can do before selling.

How the Reset Works

Every asset has a tax basis. For property someone buys, basis starts as the purchase price, plus improvements, minus any depreciation claimed.² When the owner sells, the IRS taxes the difference between the sale price and that adjusted basis.

Death changes the rule. Instead of inheriting the decedent’s original cost, the heir takes the asset at its fair market value on the date of death. All the appreciation that built up during the decedent’s lifetime disappears from the tax books. The reset applies to most capital assets: homes, commercial real estate, stocks, mutual funds, and collectibles. The asset has to be included in the decedent’s gross estate for federal estate tax purposes to qualify.¹

Federal law also treats inherited property as held long-term no matter when the heir sells.³ That matters because long-term capital gains are taxed at 0%, 15%, or 20% depending on income for 2026, compared to ordinary rates that can reach 37%. Even a sale the week after the funeral qualifies for the lower rates.

Setting the Date-of-Death Value

The valuation date is the day the decedent died. For publicly traded stocks and mutual funds, fair market value is the closing price on that date.⁴ For real estate, private business interests, and other assets without a public market price, you need a formal appraisal from a qualified independent appraiser, valued as of the date of death rather than the date the appraiser visits.²

That number becomes your basis for every future transaction with the asset. Sell it, and you subtract the stepped-up basis from the sale price. Hold it and add improvements, and those costs get added to the stepped-up figure.

If no estate tax return is filed, IRS guidance lets you use the value determined for state inheritance tax purposes as your basis.² For household items and personal property under $3,000 per item, a detailed appraisal generally isn’t required, though documenting an estimated value is still good practice.

Alternate Valuation Date

When asset values fall in the months after death, the executor can elect to value everything six months later instead. Two conditions have to be met: the estate must be large enough to require a federal estate tax return, and the election must reduce both the gross estate value and the estate tax owed.⁵ For 2026, a return is required when the gross estate plus adjusted taxable gifts reaches $15,000,000.⁶ Any asset sold or distributed before the six months are up uses its value on the date of that sale or distribution, even when the alternate date is elected for the rest of the estate.

When the Basis Steps Down

The adjustment isn’t always a gift. If an asset is worth less at the date of death than what the decedent paid, the heir’s basis steps down to the lower fair market value.⁴ The decline that occurred during the decedent’s lifetime is gone permanently.

Suppose a parent bought stock for $50,000 and it was worth $20,000 at death. Your basis is $20,000. Sell for $20,000 and you break even. Sell for $15,000 and you have a $5,000 loss, but only for the decline since you inherited it. The $30,000 lifetime loss cannot be claimed by anyone. This is why estate planners sometimes recommend selling depreciated assets before death to capture the loss on the owner’s final return.

Jointly Owned Property

Joint ownership doesn’t guarantee a full step-up, and the rule turns on who the co-owners are.

Spouses

When spouses hold property as joint tenants with right of survivorship or as tenants by the entirety, federal law automatically includes exactly half the property’s value in the deceased spouse’s gross estate, regardless of who paid.⁷ The surviving spouse gets a step-up on 50% and keeps original basis on the other 50%. The result is a blended basis: half at fair market value, half at cost.

Non-Spouse Co-Owners

For joint tenants who aren’t married, the IRS presumes the entire property belongs to the decedent’s estate unless the surviving owner can prove they contributed their own money.⁷ If a parent and adult child hold property jointly and the parent paid 100%, the whole property is in the parent’s estate and the whole property steps up. If the child can show they paid half, only the parent’s 50% adjusts. Records of who paid what are essential for non-spousal joint owners.

The Full Step-Up in Community Property States

Married couples in the nine community property states get a better result. Those states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Property acquired during the marriage is generally community property, and when one spouse dies, both halves receive a full step-up.¹

The impact is real. If a couple bought a home for $100,000 and it’s worth $900,000 when the first spouse dies, a survivor in a common law state gets a blended basis of $500,000. A survivor in a community property state gets a full $900,000. That’s $400,000 of gain wiped from the tax books.

Inherited Rental and Depreciable Property

The step-up is especially valuable for rental real estate and depreciable business assets because it wipes out the decedent’s depreciation recapture liability. When an owner sells rental property during life, previously claimed depreciation is taxed at a recapture rate of up to 25%, on top of capital gains tax. When an heir inherits, the basis resets and prior depreciation adjustments vanish. Nothing is left to recapture.

The heir then starts a fresh depreciation schedule based on the stepped-up value. Inherit a rental appraised at $400,000 at date of death, and you depreciate using $400,000 as your starting basis, allocated between land and building, regardless of what the decedent paid or claimed.² The same reset applies to commercial buildings, equipment, vehicles, and other business property. For heirs of a family business, appraise each major asset individually so the stepped-up basis can be allocated accurately across depreciation schedules.

Assets That Don’t Get a Step-Up

Several important categories are excluded. Confusing them with eligible assets is one of the costliest mistakes heirs make.

Retirement Accounts and Other IRD

Traditional IRAs, 401(k) accounts, other tax-deferred retirement plans, non-qualified annuities, and the accrued interest in U.S. savings bonds all count as income in respect of a decedent, or IRD. They don’t get a step-up because they hold income that was never taxed during the decedent’s lifetime.¹ Installment sale notes held by the decedent also fall into this category, with the unrealized gain passing to the heir as IRD rather than as a reset basis.⁸ The heir pays ordinary income tax on distributions, just as the decedent would have. If the estate owed federal estate tax, the heir can deduct the portion of that tax attributable to the IRD items.⁹

The One-Year Gift Rule

You can’t create a step-up by gifting appreciated property to a dying relative and inheriting it back. If the decedent received appreciated property as a gift within one year of death and it passes back to the original donor or the donor’s spouse, the basis stays where it was in the decedent’s hands. No step-up.¹ If the property passes to someone other than the original donor, the rule doesn’t apply and the normal step-up is available.

Trust Assets

Whether trust assets step up depends on whether they’re included in the decedent’s gross estate. Assets in a revocable living trust qualify, because the grantor kept the power to change or revoke the trust. Irrevocable trusts are trickier. If the grantor retained certain powers or interests, such as a right to trust income, the assets may still be included in the estate and eligible for a step-up. If the grantor gave up all control and benefits, the assets sit outside the estate and get no adjustment. The answer turns on the trust’s terms and how the IRS classifies the retained interests.

Documentation, Reporting, and Penalties

The stepped-up basis is only as good as the records behind it. If the IRS challenges your basis and you can’t support the number, you can end up paying tax on gains that should have been erased.

What to Keep

A certified copy of the death certificate, which anchors the valuation date.
Date-of-death appraisals for real estate and illiquid assets.²
Brokerage statements showing closing prices on the date of death for publicly traded securities.
A copy of Form 706 if the estate filed one. Values reported on that return set a ceiling on your basis.¹
Schedule A of Form 8971, the statement the executor sends each beneficiary reporting the estate tax value of property received. That reported value is your basis.¹⁰

Basis Consistency Reporting

For estates required to file Form 706, the executor must also file Form 8971 with the IRS and furnish Schedule A to each beneficiary, reporting the estate tax value of inherited assets.¹¹ The filing requirement kicks in when the gross estate plus adjusted taxable gifts equals or exceeds the basic exclusion amount, which is $15,000,000 for deaths in 2026.⁶ The heir’s basis cannot exceed the value reported on Schedule A or on the estate tax return.¹

Reporting the Sale

When you sell an inherited asset, report the transaction on Form 8949. In the date-acquired column, enter “INHERITED” instead of an actual date, and report the sale in Part II to get long-term treatment.¹² The totals flow to Schedule D.

Valuation Penalties

Inflating the stepped-up basis to reduce tax on a later sale carries consequences. If the IRS finds you substantially understated your tax because of an incorrect valuation, the penalty is 20% of the underpayment. For a gross valuation misstatement, the penalty doubles to 40%.¹³ A professional appraisal from a qualified, independent appraiser is the best protection.

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 1223 – Holding Period of Property
4
Internal Revenue Service. Gifts and Inheritances
5
Office of the Law Revision Counsel. 26 USC 2032 – Alternate Valuation
6
Internal Revenue Service. Whats New – Estate and Gift Tax
7
Office of the Law Revision Counsel. 26 USC 2040 – Joint Interests
8
eCFR. 26 CFR 1.691(a)-5 – Installment Obligations Acquired From Decedent
9
Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
10
Internal Revenue Service. Instructions for Form 706
11
Internal Revenue Service. Instructions for Form 8971 and Schedule A
12
Internal Revenue Service. Instructions for Form 8949
13
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments