Step-Up in Basis at Death: Capital Gains, Gifts, and Exceptions

Fifty Years of Unrealized Gains Can Vanish Overnight

A stock purchased in 1985 for $10,000 and worth $500,000 at death in 2024 carries $490,000 of unrealized capital gain. Without the step-up in basis rule, heirs selling that stock would owe federal capital gains tax — potentially $73,500 (at the 15% long-term rate) plus applicable state taxes. With the step-up, the heir's cost basis becomes $500,000 — the fair market value at death. The entire $490,000 gain disappears. Never taxed, not at death and not on sale. This rule, codified in Internal Revenue Code Section 1014, is one of the most valuable tax provisions available to estates and their beneficiaries, and one of the most persistently debated.

How Section 1014 Works

When a person dies owning appreciated assets, those assets receive a new tax basis equal to their fair market value on the date of death (or, if elected, an alternate valuation date six months after death). The heir who inherits those assets can sell them immediately with zero capital gains tax liability — provided the sale price matches or is below the new stepped-up basis.

The step-up applies regardless of the heir's relationship to the decedent, the size of the estate, and whether federal estate tax is owed. An estate too small to owe any estate tax still gets the full step-up benefit on all appreciated assets. Assets that have declined in value get a step-down — the basis is reduced to the lower fair market value at death, which is less commonly discussed but equally mechanically accurate.

Gifts Get Carryover Basis, Not Step-Up

The step-up only applies to assets transferred at death. Gifts made during the donor's lifetime receive carryover basis — the recipient takes the donor's original tax basis. This is a critical distinction in planning.

• A gift of stock with a $10,000 basis and $500,000 FMV gives the recipient a $10,000 basis
• If the recipient sells at $500,000, the $490,000 gain is fully taxable
• The same stock inherited (not gifted) would have a $500,000 basis — zero gain on sale

This asymmetry means that gifting highly appreciated assets during life forfeits the step-up that would otherwise occur at death. Estate planners generally recommend holding appreciated assets until death when possible, and gifting assets with low appreciation or assets expected to appreciate significantly after the gift (so future growth escapes the estate). Exception: gifts to charity during life generate an income tax deduction at fair market value without triggering capital gains, which is often superior to a charitable bequest at death.

Income in Respect of a Decedent: The Exception

Not all assets get a step-up. Income in Respect of a Decedent (IRD) assets are amounts the decedent earned or had a right to receive before death but did not receive during life. These assets carry no step-up — they are taxable income to whoever receives them, just as they would have been to the decedent.

• Traditional IRA and 401(k) balances: fully taxable as ordinary income to beneficiaries upon distribution
• Unpaid wages, salaries, and commissions owed at death
• Accrued interest on bonds not yet paid
• Installment sale gains from sales made before death
• S corporation income earned but not yet allocated at death

Heirs receiving IRD assets are entitled to a deduction for estate tax paid attributable to those assets — the Section 691(c) deduction. However, this deduction only helps estates large enough to owe estate tax in the first place.

Community Property: Double Step-Up Advantage

In the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin), property acquired during marriage generally belongs equally to both spouses. When one spouse dies, both halves of community property — not just the decedent's half — receive a step-up in basis under Section 1014(b)(6).

A couple in California owns community property stock with a $100,000 combined basis and $1 million FMV at the first spouse's death. Both spouses' shares step up. The surviving spouse's basis is now $1 million — a $450,000 gain elimination on the surviving spouse's 50% interest that would not occur in a common-law state, where only the decedent's 50% gets the step-up.

Biden Administration Proposal and Its Fate

President Biden's 2021 American Families Plan proposed eliminating the step-up in basis and instead taxing unrealized gains at death above a $1 million exemption (with provisions for family businesses and farms). The proposal was estimated to raise $322 billion over 10 years. It was not enacted. It was excluded from the Inflation Reduction Act of 2022 and has not been enacted in any subsequent legislation. The step-up in basis under Section 1014 remains unchanged as of 2025, though it remains a perennial target in federal tax policy discussions.

This article is for informational purposes only and does not constitute legal advice.