Step-Up in Basis for Inherited Assets: How It Eliminates Capital Gains

When you inherit an investment or property, the step-up in basis rule allows you to reset the cost basis to the fair market value on the date of the deceased’s death, not the deceased’s original purchase price. This erases all embedded capital gains, so you pay no capital gains tax when you later sell at the same price the asset had when you inherited it.

How the Step-Up Works

The step-up in basis is a tax provision that affects how your cost basis is calculated for inherited assets. Cost basis is the price used to determine your gain or loss when you sell.

Example:

• Great-aunt Betty bought 100 shares of Company X stock for $10 per share ($1,000 total) in 1990.
• When Betty dies in 2026, the stock is worth $50 per share ($5,000 total).
• Without a step-up, your basis would be $1,000 (Betty’s original price), and you would owe capital gains tax on the $4,000 appreciation if you sold at $5,000.
• With the step-up, your basis is $5,000 (the value on Betty’s death date), and you owe zero tax on a sale at $5,000.

The step-up is automatic for assets in a decedent’s taxable estate. You do not need to file a form or claim it; it applies by law. The executor or administrator reports the stepped-up basis to you (usually on an inheritance document or communication), and you use that figure going forward.

Which Assets Receive the Step-Up

Nearly all inherited assets receive a step-up:

• Stocks and bonds. Full step-up to fair market value at death.
• Real estate. Full step-up; this is especially valuable because real estate often appreciates significantly over decades.
• Mutual funds and ETFs. Stepped-up basis for each share or unit based on the fund’s net asset value on the death date.
• Retirement accounts (IRAs, 401(k)s). Do not receive a step-up because they are already tax-deferred. When you withdraw, you owe income tax at ordinary rates.
• Cash and cash equivalents. Technically stepped-up to the cash amount, but this doesn’t matter since cash has no gain.

Critical carve-out: Assets in most retirement accounts (traditional IRA, 401(k), Roth IRA) do not get a step-up in basis. Instead, you inherit the account and must take distributions, paying income tax on distributions from tax-deferred accounts (traditional) or enjoying tax-free withdrawals from Roth accounts (if rules are met). This is a significant disadvantage of accumulating wealth inside retirement accounts.

The Tax Elimination Effect

The step-up eliminates capital gains tax on appreciation during the deceased’s life—potentially saving the estate and beneficiaries thousands or millions of dollars.

Scenario comparison:

• Joan bought a rental property in 1975 for $100,000. It is now worth $1 million in 2026.
• If Joan sold it today, she would owe capital gains tax on $900,000 of gain (roughly $135,000 – $225,000 in federal plus state tax, depending on her bracket).
• If Joan dies owning the property, her heirs inherit at a $1 million basis. If they sell immediately at $1 million, they owe zero capital gains tax.

For wealthy estates with appreciated assets, the step-up is often one of the largest tax benefits available. It costs the federal government an estimated $40 – $60 billion annually in forgone capital gains tax.

Step-Up and the Estate Tax

The step-up applies to assets included in the decedent’s taxable estate (roughly, assets worth more than the federal estate tax exemption—currently $13.61 million per individual in 2026, with the exemption scheduled to drop to ~$7 million in 2026 unless Congress extends it).

Small estates: Most estates (those under the exemption) pay no federal estate tax and receive the step-up with no tax cost.

Large estates: Wealthy estates may owe federal estate tax (40% on amounts above the exemption), but the step-up is still applied to the assets. The estate pays estate tax on the full value at death, but heirs inherit at stepped-up basis and pay no capital gains tax on an immediate sale. This is a one-time transfer tax (estate) rather than an ongoing capital gains tax (on sale).

State Variations

A handful of states impose state-level estate or inheritance taxes. In those states, the step-up in basis is applied for state tax purposes in the same way as federal, so the state tax benefit (if any) is smaller.

Inherited Assets and Basis Planning

The step-up creates opportunities and risks:

Opportunity. If you inherit appreciated assets in a low-tax state or without state estate tax, sell them soon after inheriting to lock in the stepped-up basis before they appreciate further.

Risk. If you inherit an asset that has declined in value since the decedent’s death, you cannot choose to use the deceased’s lower original basis; you are stuck with the stepped-up basis (the higher value at death). For example, if Aunt Joan bought stock at $100 and it was worth $60 when she died, your basis is $60, not $100. If it falls to $40 and you sell, you have a $20 loss—worse than if you had inherited at Joan’s original $100 cost.

Charitable Donations and the Step-Up

A donor who donates appreciated securities to charity during life receives an income tax deduction (up to 30 – 50% of adjusted gross income) and avoids capital gains tax—a valuable combination. Upon death, donated appreciated assets are not in the estate, so no step-up is wasted. This is why wealthy donors often give appreciated assets during life rather than in their will.

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