Step-Up in Basis: How Inherited Assets Get a Tax Advantage at Death

Death Resets the Tax Clock on Appreciated Assets

Under Section 1014 of the Internal Revenue Code, assets transferred at death receive a new cost basis equal to the fair market value on the date of death — erasing decades of embedded capital gains. A stock purchased for $10,000 in 1985 that is worth $400,000 at the owner's death passes to the heir with a $400,000 basis. If the heir sells immediately, no capital gains tax is owed on the $390,000 of appreciation that occurred during the deceased's lifetime. The Congressional Budget Office estimated in 2021 that this provision shields approximately $500 billion in unrealized gains from taxation each year.

How the Step-Up Mechanism Works

The date-of-death fair market value replaces the decedent's original cost basis as the heir's starting point. If the asset has declined in value, the heir receives a step-down — the new basis is the lower fair market value, which may generate a capital loss if the asset is sold shortly after inheritance. The IRS permits an alternate valuation date (six months after death) if the estate is subject to estate tax and using that date reduces both the estate value and the estate tax liability.

Community Property States: The Double Step-Up

In the nine community property states — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin — both halves of community property receive a step-up in basis when one spouse dies. This is the double step-up, and it is a significant advantage over common-law states.

• In a common-law state, only the deceased spouse's share (typically 50%) receives a step-up
• In a community property state, both the decedent's share and the surviving spouse's share are stepped up to date-of-death values
• A couple in California who jointly owns stock worth $2,000,000 (bought for $100,000) loses all $1,900,000 of embedded gain at the first spouse's death
• Alaska allows couples to opt into community property treatment to gain this benefit

Assets That Do NOT Receive a Step-Up

Not all inherited assets benefit from Section 1014. Several categories are excluded by statute or design.

Estate Planning Strategies Built Around the Step-Up

The step-up in basis creates powerful planning opportunities for families with concentrated, low-basis positions.

• Hold, don't sell: Highly appreciated assets held until death pass gains-free to heirs; selling before death generates taxable income
• Gift appreciated property strategically: Gifting low-basis assets to heirs before death transfers carryover basis — heirs keep the embedded gain; gifting to charities instead via donor-advised funds eliminates the gain entirely
• Swap low-basis assets into the estate: Some irrevocable trusts allow substitution of high-basis assets to bring low-basis appreciated assets back into the estate, capturing the step-up
• Spousal transfers: In community property states, restructuring separate property as community property before death can unlock the double step-up

The Proposed Changes That Never Passed

President Biden's 2021 American Families Plan proposed eliminating the step-up in basis for gains over $1 million per individual, replacing it with a realization event at death. Congress did not pass the proposal. Periodically, legislative proposals would replace Section 1014 with a carryover basis regime — where heirs assume the decedent's original basis — but as of 2024 the step-up remains fully intact. It is widely discussed as a future revenue target given its estimated $50 billion annual cost to the federal government.

This article is for informational purposes only and does not constitute financial or tax advice.