Capital Gains Tax on Inherited Stock

When you inherit stock, the IRS grants a powerful relief: capital gains tax on inherited stock is calculated from the asset’s market value on the date of death, not the original purchase price. This reset—called “stepped-up basis”—can eliminate decades of accrued gains from the tax system. You owe tax only on appreciation that occurs after you inherit.

How the step-up works: a concrete example

Suppose your mother purchased 1,000 shares of a tech stock for $20 per share in 1995, investing $20,000. By the time she passed away in 2024, the stock had appreciated to $150 per share—an unrealized gain of $130,000.

Without the stepped-up basis, that $130,000 gain would eventually be owed by her estate or passed along as a tax liability. Instead, on the date of her death, you as her heir inherit a new “basis”—the date-of-death fair market value of $150 per share.

You inherit 1,000 shares with a cost basis of $150,000. If you sell immediately, you owe no tax. If you hold and sell at $160 per share a year later, you owe long-term capital gains tax on only the $10,000 post-inheritance gain—not the original $130,000.

The estate owes no tax on the pre-death appreciation. Your mother’s final income tax return does not include the $130,000 as taxable income. The gain simply vanishes from the tax system.

Why this matters for large estates

Stepped-up basis is one of the largest tax breaks available to heirs and is why inherited securities are often more valuable than inherited cash. A millionaire who accumulated $500,000 in unrealized gains across a diversified portfolio can pass that entire position to heirs with zero capital gains tax owed—immediately or ever—so long as the heirs hold indefinitely or sell at the stepped-up basis value.

This creates a stark disparity: an heir who sells inherited stock in the week after inheriting owes no tax, even if the decedent held it for 30 years. A wage earner who invests that same $500,000 salary over 30 years and then sells the appreciating position faces a substantial capital gains tax bill. The difference in after-tax wealth can be hundreds of thousands of dollars.

The step-up is intentionally designed: the tax code assumes that the decedent’s income was taxed when earned; the subsequent appreciation is viewed as a fresh start for the heir.

Interaction with holding period

Inherited stock is automatically treated as long-term capital gain property regardless of how long the decedent held it or how long you hold it. If you inherit in June and sell in July, one month later, the gain is taxed at long-term capital gains rates—not short-term rates. This is an additional advantage: the usual one-year holding requirement is waived.

However, the one-year clock does not restart. If you inherit stock that will generate a loss—because the value dropped after death—and you want to harvest that loss, the holding period is typically still considered long-term by the IRS, and you benefit from long-term loss treatment (though capital losses are netted against capital gains regardless of term).

When stepped-up basis does not apply

Several important exceptions exist:

Ordinary income property. Stepped-up basis applies to capital assets (stocks, bonds, real estate, collectibles). Income property does not step up. If the decedent owned an unpaid dividend on a stock or accrued interest on a bond, those are income in respect of a decedent and are taxed to the estate or heir as ordinary income, not capital gains.

U.S. savings bonds. Inherited savings bonds do not receive a stepped-up basis; accrued interest is taxed to the heir when redeemed.

Appreciated assets inside an IRA or 401(k). Inherited retirement accounts do not receive a stepped-up basis. Beneficiaries inherit the pre-tax value and owe income tax on withdrawals (though post-tax Roth accounts can be inherited tax-free). The step-up applies to the non-qualified assets in the estate, not the retirement plan assets.

Community property states. In nine community property states, both spouses’ shares of community property receive a stepped-up basis upon the death of either spouse—doubling the benefit for married couples. In other states, only the deceased spouse’s share steps up.

Effect on the estate’s tax basis

The stepped-up basis adjustment is made on the estate’s final income tax return (Form 1041) and the Schedule D that accompanies it, or on the basis records of the inheriting entity. The fiduciary must track the “final value”—the appraised value on the death date—to document the step-up for tax records. This value is also used to calculate any estate tax owed (estates over $13.61 million in 2024 face federal estate tax).

Heirs should request an accounting from the estate that lists the basis of each inherited asset. Failure to establish the proper stepped-up basis can trigger a dispute with the IRS if a future sale is audited.

Uncertainty and legislative risk

The stepped-up basis rule faces periodic political scrutiny. Since 2021, proposals to limit or repeal the step-up for high-net-worth estates have circulated in Congress. Under some proposals, a portion of unrealized gains would be taxed at death (“carry-over basis”), or the step-up would be eliminated for estates above a certain threshold. Such changes would substantially increase the tax burden on heirs.

As of now, the step-up remains intact. But heirs of large estates should monitor legislative changes and consider tax planning for estates large enough to face federal estate tax, where step-up and estate tax interact.

Planning implications

Because the step-up is automatic and requires no election or filing, there is no timing advantage to claiming it. However, there are strategic considerations:

Hold until inheritance. If an elderly person with large unrealized gains expects to die soon, holding appreciated assets until death may result in lower heirs’ tax bills than selling during the decedent’s life.

Diversification. Conversely, an elderly person with concentrated, appreciated positions can harvest losses or rebalance within their lifetime if they wish to avoid passing concentrated risk to heirs, even though the step-up makes the tax bill negligible.

Basis documentation. Keeping clear records of purchase price and decedent’s holding date, while less critical than in prior law, still aids in demonstrating the pre-death appreciation for planning and audit purposes.

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