What Is IRC 1014? Step-Up in Basis Rules for Inherited Assets

The step-up in basis is a federal tax rule that resets the cost basis of inherited property to its fair market value on the date the previous owner died, wiping out capital gains that built up during that person’s lifetime.¹ The rule lives in Section 1014 of the Internal Revenue Code, and it applies to every eligible asset regardless of whether the estate owes any federal estate tax. For an heir who inherits a home that appreciated by $400,000 over decades, the reset can eliminate tens of thousands of dollars in capital gains tax that would otherwise come due at sale.

How the Reset Works

Capital gains tax is calculated on the difference between the sale price and your basis in the asset. Basis is normally the original purchase price plus improvements. For inherited property, basis is instead the fair market value on the date of death.²

An example makes the mechanics concrete. Suppose your parent bought stock for $20,000, and it was worth $115,000 when they died. If you sell it for $120,000, your taxable gain is $5,000, not $100,000. The $95,000 of appreciation that occurred during your parent’s lifetime is never taxed as capital gain to anyone.

The size of the estate does not matter. A $500,000 estate gets the same basis adjustment as a $50 million one. The property just has to have been acquired from a decedent within the meaning of the statute, and no estate tax return has to be filed for the step-up to apply.³

The adjustment cuts both ways. If the asset lost value during the decedent’s ownership, basis “steps down” to the lower fair market value at death. You cannot use the decedent’s higher original cost to claim a loss on a later sale.

Why Inheriting Beats Receiving a Gift

If someone gives you property while alive, you take their original cost as your basis. This is called carryover basis.⁴ Using the same numbers, a lifetime gift of that $115,000 stock with a $20,000 original cost leaves you with a $20,000 basis and a $95,000 taxable gain on sale. Inheriting the same stock resets your basis to $115,000, and the $95,000 disappears.

That difference drives a lot of estate planning. Parents holding highly appreciated assets like long-held rental property, concentrated stock positions, or a family business often keep those assets until death specifically so heirs get the reset. The math changes if the asset is losing value or the owner needs liquidity, but for appreciated property, inheritance almost always beats a lifetime gift.

What Assets Qualify

The statute covers property received by bequest, inheritance, or through the decedent’s estate.¹ That includes:

Real estate of every kind, from primary homes to vacation properties, rentals, and undeveloped land.
Stocks, bonds, mutual funds, and ETFs held in taxable brokerage accounts.
Ownership stakes in partnerships, LLCs, S corporations, and sole proprietorships.
Personal property with significant value, including art, collectibles, and vehicles.

Assets held in a revocable living trust also qualify because the trust property is treated as part of the decedent’s gross estate.² Foreign property qualifies too. Section 1014 has no geographic restriction and specifically references community property under the laws of any foreign country, provided the property is included in the decedent’s gross estate.¹

Life insurance is often assumed to be part of this discussion, but it sits outside the framework. Death benefits are generally excluded from the beneficiary’s gross income under a separate provision, so the proceeds arrive tax-free without needing any basis adjustment.⁵

What Doesn’t Get the Reset

Two carve-outs regularly surprise heirs.

Retirement Accounts and Other Deferred Income

Traditional IRAs, 401(k) accounts, and similar deferred-tax assets do not step up. They fall into a category the tax code calls “income in respect of a decedent” — money the decedent had earned or had a right to receive but had not yet been taxed on.¹ Because those funds were never taxed as income to the original owner, Congress denied them the basis reset. Distributions from an inherited traditional retirement account are taxed as ordinary income to the beneficiary, just as they would have been to the decedent.

Other items in this category include unpaid salary, accrued but uncollected interest, and installment sale payments the decedent had not yet received. Roth IRAs generally sit outside this exclusion because qualified distributions are already tax-free.

Appreciated Property Given Back Within a Year

The statute blocks a specific maneuver: gifting appreciated property to a terminally ill person and hoping to get it back at a stepped-up basis when they die. If appreciated property was gifted to the decedent within one year of death and passes back to the original donor or the donor’s spouse, basis stays at the decedent’s adjusted basis rather than resetting to fair market value.¹ The rule only bites when the property boomerangs back to the donor. If it passes to a different beneficiary, the normal step-up applies.

How Ownership Structure Changes the Answer

For married couples, how much of a jointly owned asset actually steps up depends on the state and the form of ownership.

Joint Ownership in Common Law States

In most states, when a married couple owns property as joint tenants, only the decedent’s half gets the basis adjustment. The surviving spouse’s half keeps its original cost. Consider a home the couple bought together for $200,000, worth $600,000 when the first spouse dies. The surviving spouse’s new basis is $400,000: the original $100,000 basis on their half, plus the stepped-up $300,000 on the decedent’s half.² Selling for $600,000 triggers tax on $200,000 of gain.

Community Property States

Nine states treat most assets acquired during marriage as community property: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.⁶ In these states, both halves of a community property asset get the basis adjustment when one spouse dies.³ Same house, same numbers: the surviving spouse’s full basis becomes $600,000, and an immediate sale produces no taxable gain.

At least half of the community interest must be includible in the decedent’s gross estate for the full adjustment, but an estate tax return is not required. For couples with highly appreciated real estate or long-held stock portfolios, the difference between the two systems can be enormous.

Proving the Value

The step-up is only as strong as the valuation supporting it. Weak documentation invites IRS scrutiny.

Publicly traded securities are simple. Fair market value is the closing price on the date of death, or the average of the high and low trading prices depending on the method used. Brokerage firms usually generate this figure automatically.

For real estate and closely held businesses, a formal appraisal is what stands up. A licensed appraiser produces the valuation; a residential appraisal typically runs from roughly $300 to $500 for a standard home, with complex or high-value properties costing more. For closely held business interests, the IRS looks at earning capacity, book value, financial condition, and industry outlook.⁷ Minority interests and interests that lack marketability often carry valuation discounts, which lowers the stepped-up basis but also reduces the taxable estate.

The Alternate Valuation Date

The executor can elect to value all estate assets six months after death instead of on the date of death.⁸ The election is only available if it reduces both the total gross estate and the estate tax owed.⁹ If an asset is sold or distributed before the six-month mark, its value on the date of sale or distribution is used. The election covers the whole estate; the executor cannot pick and choose. This mostly matters for taxable estates where markets dropped after the death.

Selling Inherited Property Is Always Long-Term

Inherited property is automatically treated as held for more than one year, even if you sell it the day after the decedent’s death.¹⁰ That matters because long-term capital gains are taxed at preferential rates of 0%, 15%, or 20% depending on income, instead of the higher ordinary income rates that hit short-term gains. For 2026, single filers pay 0% on long-term gains up to $49,450 of taxable income and 15% up to $545,500.

Reporting and Penalties

For 2026, the federal estate tax filing threshold is $15,000,000.¹¹ Estates below that number do not file Form 706, and the special reporting rules that follow do not apply. The heir uses fair market value at death supported by appraisals or market data.

When an estate does file Form 706, the executor must also file Form 8971 with the IRS and send a Schedule A to each beneficiary listing the assets they received and the estate tax value assigned to each.¹² Under the consistent basis rule in Section 1014(f), a beneficiary’s basis cannot exceed the value reported on the estate tax return when inclusion of the property increased the estate tax liability.¹ In plain terms, you cannot claim a higher basis on your income tax return than what the executor reported.

The penalty for reporting a basis higher than the value on your Schedule A is 20% of the resulting tax underpayment, and it climbs to 40% for gross valuation misstatements.¹³ The safest course is to use the Schedule A value as your basis and go back to the executor if you believe it is wrong.

1
Office of the Law Revision Counsel. 26 USC 1014 Basis of Property Acquired From a Decedent
2
Internal Revenue Service. Publication 551 (12/2025), Basis of Assets
3
eCFR. 26 CFR 1.1014-2 Property Acquired From a Decedent
4
eCFR. 26 CFR 1.1015-1 Basis of Property Acquired by Gift
5
eCFR. 26 CFR 1.101-1 Exclusion From Gross Income of Proceeds of Life Insurance Contracts Payable by Reason of Death
6
Internal Revenue Service. Publication 555 (12/2024), Community Property
7
Internal Revenue Service. Valuation of Assets
8
Office of the Law Revision Counsel. 26 USC 2032 Alternate Valuation
9
eCFR. 26 CFR 20.2032-1 Alternate Valuation
10
Office of the Law Revision Counsel. 26 USC 1223 Holding Period of Property
11
Internal Revenue Service. Whats New Estate and Gift Tax
12
Internal Revenue Service. Instructions for Form 8971 and Schedule A
13
Office of the Law Revision Counsel. 26 USC 6662 Imposition of Accuracy-Related Penalty on Underpayments