Basis Step-Up at Inheritance

A basis step-up at inheritance is a provision of US tax law that resets the cost basis of inherited assets to their fair market value on the date of the decedent’s death. This allows heirs to avoid taxation on all appreciation that occurred during the original owner’s lifetime. Upon inheritance, an heir’s basis is “stepped up” from the original purchase price to the current market value, effectively wiping out the deferred capital gain.

Imagine an investor buys a stock for $10 per share and holds it for 40 years until it reaches $100 per share. During that time, the investor dies. The heir inherits the stock. Instead of inheriting a basis of $10 (and owing capital gains tax on the $90 gain if they sell), the heir’s basis is stepped up to $100—the value at death. If the heir sells immediately at $100, there is zero capital gains tax. The $90 of unrealized appreciation is never taxed.

This is one of the most valuable provisions in the US tax code for wealthy families. It allows multi-generational wealth transfer with significant tax savings and is a cornerstone of estate planning.

The mechanism

A decedent owns securities and real estate with significant embedded gains. At death, the executor files an estate tax return (Form 706) and values all assets at fair market value on the date of death (or six months later, the alternate valuation date). The heir receives those assets; their basis is this “stepped-up” value.

Example:

• Decedent purchased Stock X for $10,000 (100 shares at $100/share).
• Stock X appreciates to $50,000 at death (100 shares at $500/share).
• Heir inherits Stock X with a basis of $50,000 (the step-up value).
• If heir sells immediately at $50,000, capital gains tax = $0.
• The $40,000 gain is forever untaxed.

Without this provision, the heir would inherit a basis of $10,000, triggering $40,000 in capital-gains-tax upon sale. With the step-up, the heir avoids the tax.

Estate tax interaction

The step-up is only available if the estate is large enough that an estate tax return (Form 706) must be filed. The 2024 federal estate tax exemption is $13.61 million per person; estates below that threshold are not required to file and do not receive a formal step-up. However, the step-up is available for all inherited assets, even in small estates that don’t trigger an estate tax return. The IRS assumes step-up basis in inherited assets unless the estate is large enough to report.

If the estate exceeds the exemption, estate-tax applies to the excess at a 40% rate. So a very large estate might pay 40% federal estate tax on some assets, but the remainder is stepped-up to death value and heir receives a higher basis.

This can be tax-efficient: pay 40% estate tax on the high-value assets, but allow the heir to inherit a stepped-up basis and avoid capital-gains tax on the gains. In some scenarios, it is cheaper than the original owner selling and paying capital-gains tax during life.

Real estate and depreciation recapture

For depreciated real property (e.g., rental buildings), the step-up applies to the entire property value, including the accumulated depreciation recapture. If an owner purchases a rental property for $1M, depreciates it to $700k (book value), and the property appreciates to $2M at death, the heir’s basis is stepped-up to $2M. If the heir sells immediately for $2M, there is zero capital gains tax on the $1.3M gain ($2M sale less $700k stepped-up basis). Additionally, the heir does not owe depreciation-recapture-tax on the previously deducted depreciation.

This is a significant advantage of holding appreciated real estate to death; both the appreciation and the depreciation benefits are passed tax-free.

Limitation: Capital gains tax on appreciation after death

The step-up applies only to appreciation during the decedent’s lifetime. If an heir inherits an asset at stepped-up value and then sells it months later at a higher price, the heir owes capital-gains tax on the post-inheritance gain. So the step-up is a one-time reset at death; subsequent gains are taxable.

Carryover basis (the exception)

For certain property acquired before 2010, carryover basis rules applied (a temporary reversion that almost no estates use). Under carryover basis, the heir inherited the decedent’s original basis with an adjustment for any estate tax paid. This essentially required heirs to keep track of historical basis and recognize gains. Congress has since reverted to step-up basis for all post-2009 inheritances (the carryover basis sunset). Unless the decedent purchased property before 2010 and no Form 706 was filed, step-up basis is the rule.

Federal estate tax but no step-up

A strategic consideration: if an estate owes federal estate tax, the executor must file Form 706 and report the stepped-up values. If the estate is small (below the exemption), no Form 706 is required but the step-up still applies. In small estates, the heir may request the executor informally document the date-of-death value for their records, or rely on appraisals from the real estate or brokerage, but no tax filing is necessary.

State estate taxes and step-up

A handful of states (New York, Massachusetts, Oregon, etc.) have state-level estate taxes with lower exemptions. If you are domiciled in such a state, state estate tax may apply even if federal tax doesn’t. Additionally, some states have not conformed to federal step-up rules; inherited assets may face state capital-gains tax even after a federal step-up. Always check state law for residents of high-tax states.

Planning implications

The step-up incentivizes holding appreciated assets to death rather than selling during life. This creates tax inefficiency:

• An owner with $5M in appreciated stock feels no urgency to sell and diversify, because the step-up will wipe out the tax.
• The wealth is concentrated and exposed to market risk, but tax deferral encourages holding.
• Conversely, holding to death forgoes the opportunity to recognize losses for tax-loss harvesting purposes during the owner’s life.

Estate planners often recommend:

• Gifting appreciated assets to heirs during life, within the annual gift tax exclusion ($18k per donor per recipient in 2024), if the goal is to transfer wealth. The heir receives a carryover basis but avoids the capital gains tax on post-gift appreciation.
• Recognizing losses in appreciated positions during life, if diversification is needed. Harvest losses to offset other gains.
• Charitable giving. Donating appreciated assets to charity avoids capital-gains tax and generates an income-tax deduction, making it more tax-efficient than selling then donating the proceeds.
• Utilizing the step-up for the largest unrealized gains. If you own multiple assets, you want the highest-gain assets to pass to heirs at death (step-up) and lower-gain assets to be sold or given away during life (paid-tax or gifted).

Is the step-up under threat?

The step-up is a perennial target of tax reform. Progressives argue it is an unjustified subsidy for wealthy families; conservatives defend it as important for family business and farm continuity. In 2021–2022, the Biden administration proposed eliminating the step-up for estates over $1M, but Congress did not enact it. As of 2024, the step-up remains fully available. However, future tax reform could narrow or eliminate it.