What is a Step-Up in Basis?

Step-up in basis (also called stepped-up basis) is a tax provision that resets the cost basis of an inherited asset to its fair market value at the date of the owner’s death. This eliminates capital gains taxes on all appreciation that occurred during the deceased person’s lifetime.

If your parent bought stock for $10,000 and it’s worth $200,000 when they die, you inherit it with a basis of $200,000, not $10,000. If you sell it the next day for $200,000, you owe zero capital gains tax. Without the step-up, you’d owe taxes on $190,000 of gains that built up over decades.

How Step-Up in Basis Works at Death

Under IRC Section 1014, when someone dies, most appreciated assets they own receive a new cost basis equal to their fair market value on the date of death. The original purchase price and any accumulated gains are effectively erased for tax purposes.

Example:

Assets that typically receive a step-up:

• Stocks, bonds, and mutual funds in taxable brokerage accounts
• Real estate (primary residence, rental properties, land)
• Business interests
• Collectibles and other capital assets

Assets that do NOT receive a step-up:

• Retirement accounts (IRAs, 401(k)s, 403(b)s); these are taxed as ordinary income when withdrawn regardless
• Tax-deferred annuities (generally)
• Assets in certain irrevocable trusts (depends on trust structure)

Step-Up in Basis: One-Year Rule

The one-year rule prevents a specific abuse: gifting appreciated property to a dying person just to get the step-up when it’s inherited back.

Under IRC Section 1014(e), if you gift appreciated property to someone who dies within one year, and the property passes back to the original donor (or their spouse), the step-up doesn’t apply. The basis reverts to whatever the deceased’s basis was, which is the original donor’s carryover basis.

This rule only applies when the asset returns to the person who gave it (or their spouse). If the deceased leaves it to someone else entirely, the step-up applies normally.

Step-Up in Basis When a Spouse Dies

When a spouse dies, how much of a step-up you get depends on how the property is titled and which state you live in.

Common law states (most states): Only the deceased spouse’s share of jointly owned property receives a step-up. If a couple owns a home 50/50 that was purchased for $200,000 and is worth $600,000 at death, the surviving spouse gets a step-up on the deceased’s half (basis goes from $100,000 to $300,000) but keeps their original basis on their half ($100,000). The surviving spouse’s total basis is $400,000.

Community property states: Both halves of community property receive a full step-up. Using the same example, the surviving spouse’s total basis would be $600,000, the full fair market value. This is one of the most significant tax advantages of community property and can save tens or hundreds of thousands in capital gains taxes.

This only applies to assets that are actually community property. Property acquired before the marriage, by gift, or by inheritance remains separate property and follows common-law step-up rules (only the deceased’s share gets a step-up), even in a community property state.

Community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Alaska and South Dakota allow couples to opt in.

If you’re a surviving spouse replanning your finances, you can model how inherited assets with stepped-up basis affect your capital gains exposure under different liquidation timelines.

Step-Up in Basis and Trusts

Whether trust assets receive a step-up depends on the trust type:

Revocable trusts (living trusts): Assets get a full step-up. Because the grantor retains control, the assets are included in their gross estate for estate tax purposes, and inclusion in the gross estate is what triggers the step-up under Section 1014.

Irrevocable trusts: Generally no step-up, because the grantor has given up ownership and the assets aren’t included in their gross estate. There are exceptions: certain irrevocable trusts (like intentionally defective grantor trusts) may still be included in the gross estate depending on the trust terms, in which case the assets can receive a step-up.

The trust question comes up frequently in estate planning because people set up irrevocable trusts for asset protection or estate tax reduction without realizing they may be giving up the step-up benefit. The trade-off between estate tax savings and capital gains step-up is worth modeling before making that decision.

Frequently Asked Questions

What is a step-up in basis? When you inherit an asset, its cost basis resets to the fair market value at the date of death. This means you only owe capital gains taxes on appreciation that occurs after you inherit it, not on gains that built up during the original owner’s lifetime.

Do retirement accounts get a step-up in basis? No. IRAs, 401(k)s, and other tax-deferred retirement accounts don’t receive a step-up. Withdrawals from inherited retirement accounts are taxed as ordinary income, the same as they would have been for the original owner.

What is the one-year rule for step-up in basis? If you gift appreciated property to someone who dies within one year, and the property comes back to you (or your spouse) through their estate, you don’t get a step-up. This prevents people from gifting assets to a terminally ill relative just to get the tax benefit.

Do community property states get a double step-up? Yes. In community property states, both halves of community property receive a step-up when one spouse dies, not just the deceased spouse’s half. In common law states, only the deceased spouse’s share gets the step-up. This can result in significantly lower capital gains taxes for surviving spouses in community property states.