What is Step-Up in Basis?
Step-up in basis is a tax benefit that resets the cost basis of inherited assets to their fair market value at the date of death. Any unrealized capital gains that accrued during the decedent's lifetime are effectively erased, allowing beneficiaries to inherit assets at current market value.
How Step-Up in Basis Works
| Stage | Original Owner | Heir (After Step-Up) |
|---|
| Purchase Price | $50,000 | N/A |
| Value at Death | $500,000 | $500,000 (new basis) |
| Unrealized Gain | $450,000 | $0 |
| Tax if Sold at $500K | $450,000 gain taxed | $0 gain (no tax) |
Step-Up in Basis Example
| Factor | Amount |
|---|
| Original Purchase (1985) | $100,000 |
| Fair Market Value at Death (2025) | $1,000,000 |
| Unrealized Gain (Eliminated) | $900,000 |
| Heir's New Cost Basis | $1,000,000 |
| If Heir Sells for $1,050,000 | Only $50,000 gain taxed |
Assets Eligible for Step-Up in Basis
| Eligible Assets | Not Eligible |
|---|
| Stocks and bonds | IRAs and 401(k)s (already tax-deferred) |
| Real estate | Annuities (have own tax rules) |
| Mutual funds and ETFs | Assets in revocable trusts (varies) |
| Business interests | Gifted assets (carryover basis) |
| Collectibles | Property transferred before death |
Step-Up vs. Carryover Basis
| Scenario | Basis Rule | Example |
|---|
| Inherited Asset | Step-up to FMV at death | Original $10K, death value $100K = $100K basis |
| Gifted Asset | Carryover (donor's basis) | Donor's $10K basis carries to recipient |
Valuation Date Options
| Option | When Used |
|---|
| Date of Death | Default - FMV on date of death |
| Alternate Valuation Date | 6 months after death (if elected and reduces estate tax) |
Community Property Advantage
| State Type | Step-Up Applies To |
|---|
| Community Property States | BOTH halves of community property (double step-up) |
| Common Law States | Only decedent's half of jointly-held property |
Community property states: AZ, CA, ID, LA, NV, NM, TX, WA, WI
Step-Up in Basis and Estate Planning
| Strategy | Benefit |
|---|
| Hold appreciated assets until death | Eliminates capital gains for heirs |
| Avoid gifting highly appreciated assets | Gifts use carryover basis (no step-up) |
| Use step-up for estate liquidity | Heirs can sell immediately without large tax |
Limitations and Considerations
| Factor | Impact |
|---|
| Step-Down in Basis | If asset declined in value, basis steps DOWN to FMV |
| Estate Tax | Large estates may owe estate tax (separate from step-up) |
| Documentation | Heir must establish FMV at date of death |
| Holding Period | Inherited assets are automatically long-term |
Exam Alert
Key exam points for Step-Up in Basis:
- Inherited assets receive a step-up (or step-down) to FMV at DATE OF DEATH
- Unrealized gains are ELIMINATED - heirs inherit at current market value
- Gifted assets do NOT receive step-up - they use CARRYOVER BASIS (donor's basis)
- Community property states allow DOUBLE step-up for surviving spouse
- IRAs/401(k)s do NOT get step-up - distributions are taxed as ordinary income regardless
- Inherited assets are treated as LONG-TERM regardless of actual holding period
- Alternate valuation date (6 months) may be elected if it REDUCES estate value