Step-Up in Cost Basis for an Inherited Home

When you inherit a home, its step-up in cost basis resets the property’s tax cost to its fair market value on the date of death, eliminating most or all of the accrued capital gains the original owner never paid tax on. If an elderly parent bought a house for $150,000 in 1980 and it was worth $800,000 on death in 2024, the heir’s tax cost basis jumps to $800,000, not $150,000. A quick sale after inheriting triggers only taxes on any appreciation after the death date—often none or minimal gains.

Why the step-up exists

The step-up in basis is a longstanding feature of US tax law (IRC § 1014). The underlying logic: capital gains tax is designed to tax the gain accrued during the taxpayer’s holding period. When someone dies, ownership transfers; the new owner (heir) did not earn the pre-death appreciation. Taxing the heir on gains the decedent never paid tax on amounts to double taxation across two lifespans.

Instead of the heir inheriting a $150,000 basis and owing tax on $650,000 in gain, the law allows a “step-up” to $800,000. The accrued gain is effectively forgiven at death. This is why wealthy families often hold appreciated assets until death rather than gifting them during life; a gift preserves the low basis in the recipient’s hands, whereas inheritance resets it.

How the step-up calculation works

Basic formula:

Without the step-up, the heir’s taxable gain would have been $660,000 ($810,000 sale price minus $150,000 original basis), and the tax bill would exceed $132,000. The step-up saves $130,000 in this example.

Valuation on the date of death

The fair market value used for the step-up is determined as of the decedent’s date of death. For real estate, this is typically the appraisal value used for estate tax purposes (if the estate is large enough to file a Form 706). For publicly traded stocks, it is the closing price on the date of death.

If the decedent owned a primary residence, there is often no appraisal unless the estate must file an estate tax return (total gross estate exceeding $13.61 million in 2024, indexed annually). In those cases, a professional appraisal is standard. For smaller estates, the executor and heir may rely on comparable sales or a real estate agent’s opinion, though the IRS may challenge the valuation if the asset is later sold at a significantly different price.

Key point: The step-up basis is the FMV on death, not the sale price. If the property drops in value after the heir takes ownership, the heir’s basis is still the higher death date value, and the heir may have a capital loss if sold.

Holding period reset

A unique advantage: the heir’s holding period for capital gains purposes starts fresh on the date of death. Even if the decedent held the home for 40 years, the heir is treated as having held it for long-term purposes immediately. This means a sale one day after inheriting qualifies for the preferential long-term capital gains rate (0%, 15%, or 20% in recent years), not the shorter-term rate that applies to assets held less than one year.

This is often the case with inherited real estate: an elderly parent dies, the heir inherits and sells quickly to settle the estate or simplify affairs, and the short holding period is not a tax problem because the law grants long-term status at death.

Stepped-up basis and mortgages

If the inherited home carries a mortgage, the step-up basis applies to the property’s value, not the equity. If a house worth $800,000 has a $200,000 mortgage, the heir’s basis is $800,000. The heir takes on the debt obligation but the tax basis is unaffected. The step-up reduces the heir’s net taxable gain on eventual sale, even if the property is encumbered.

Limitations and exceptions

Inherited IRAs and retirement accounts: The step-up does NOT apply to 401(k) plans, traditional IRAs, or Roth IRAs. Inherited retirement accounts are taxed as income to the heir under the Secure Act rules (2020), which required most heirs to withdraw all funds within 10 years. The step-up is irrelevant because the assets are not subject to capital gains tax.

Community property states: In Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin, spouses may own property as community property. Both halves of the community property receive a step-up in basis at the death of either spouse, not just the half owned by the deceased. This is a significant tax advantage in those states.

Recent legislative efforts: Some proposed reforms would eliminate or limit the step-up basis for very large estates. As of 2024, no such change has passed, but it remains periodically discussed in tax policy debates.

Practical example: timing and the real payoff

An elderly homeowner buys a house in 1985 for $200,000. Today it is worth $1.2 million. If the owner sells now, the capital gain is $1 million, taxed at 20% (federal long-term rate) = $200,000 in tax, plus state tax, possibly net investment income tax.

If the owner holds the home and dies with an estate plan, the heir inherits at a basis of $1.2 million. If the heir sells the next month for $1.2 million (no appreciation), there is zero capital gain and zero tax.

Conversely, if the heir holds and the market rises, only the post-death appreciation is taxed. The pre-death $1 million is permanently sheltered.

Reporting the step-up basis

When an heir sells inherited real estate, the step-up basis must be reported on Schedule D (capital gains/losses). The cost basis line shows the FMV on death, not the original purchase price. The executor or estate attorney typically provides documentation of the date-of-death valuation for the heir’s tax return.

The IRS can audit the basis claimed if it is significantly higher than the sale price or if comparable sales in the area suggest a lower FMV at death. Documentation (appraisals, estate tax returns, real estate valuations) protects the heir’s position.

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