Step-Up in Basis: How Inherited Property Is Taxed

What Is Step-Up in Basis?

Cost basis is the original value of an asset for tax purposes, generally what was paid for it. When you sell an asset, you owe capital gains tax on the difference between the sale price and your cost basis. A higher basis means less taxable gain; a lower basis means more.

The step-up in basis rule, codified in Section 1014 of the Internal Revenue Code, provides that when a person inherits property from a decedent, the heir's basis in that property is "stepped up" to the property's fair market value on the date of the decedent's death. The original purchase price paid by the deceased has no bearing on the heir's capital gains calculation. If terms like "cost basis," "fair market value," or "IRD" are unfamiliar, our estate planning glossary defines common estate and tax terms.

This rule is covered by IRS Publication 551, Basis of Assets, which provides detailed guidance on how to determine basis for various types of property, including inherited assets. Additional guidance is available through IRS Tax Topic 703, Basis of Assets.

How the Step-Up in Basis Works: A Simple Example

The best way to understand the step-up in basis is through a concrete example.

Joint Ownership Rules: How the Step-Up Works for Co-Owned Property

The step-up in basis rules for jointly owned property differ between common law states and community property states.

In common law (non-community property) states, when spouses own property as joint tenants with right of survivorship (JTWROS) or as tenants by the entirety, only the deceased spouse's half of the property gets a step-up in basis. The surviving spouse's half retains its original basis.

Here is an example in a common law state: spouses bought a house together for $200,000 (each spouse's basis equals $100,000). The house is worth $700,000 when one spouse dies. The surviving spouse's basis becomes: $100,000 (their original half) plus $350,000 (step-up on deceased spouse's half), totaling $450,000. If they sell for $700,000, the taxable gain is $250,000.

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), both halves of community property receive a full step-up in basis at the death of either spouse. Using the same example: the surviving spouse's entire basis becomes $700,000, the full fair market value. If they sell for $700,000, the taxable gain is $0. This is a substantial advantage compared to common law states.

For property held by a single individual (not jointly owned), the heir's basis equals the full fair market value at death, regardless of which state the property is located in. To understand how this connects to the broader question of inherited assets, see our inheritance guide.

What Doesn't Get a Step-Up: Income in Respect of a Decedent

Not all inherited assets benefit from the step-up in basis. Assets classified as "income in respect of a decedent" (IRD) are excluded from the step-up rule because they represent income the deceased had a right to receive but had not yet received or paid tax on at the time of death.

Traditional IRAs and 401(k) plans are the most common IRD assets. When you inherit a traditional IRA, you inherit the tax deferred inside it. Every distribution you take from an inherited IRA is taxed as ordinary income, just as it would have been for the original owner. There is no step-up in basis for these accounts. Under the SECURE Act 2.0, most non-spouse beneficiaries must empty an inherited IRA within 10 years of the original owner's death.

Annuities also fall into the IRD category. The growth inside a non-qualified annuity is tax-deferred during the original owner's lifetime. When a beneficiary inherits and surrenders an annuity, the gain above the original investment (the cost basis) is taxable as ordinary income. There is no step-up.

Savings bonds may also carry embedded interest income that the decedent had not yet reported. The heir must include that interest in their own income when the bond is redeemed.

The mix of IRD assets and other inherited assets affects the after-tax value heirs actually receive. These differences can inform decisions about how assets are held while planning an estate. For a broader view of estate tax considerations, see our estate tax calculator. Our estate planning guide also explains how structuring assets correctly during life can maximize the step-up benefit for your heirs.

How to Determine Fair Market Value at Death

The step-up in basis requires establishing the asset's fair market value on the date of death. How this is determined depends on the type of asset:

• Publicly traded stocks and mutual funds: The average of the high and low trading price on the date of death (or the mean price, per IRS rules) as reported on the stock exchange.
• Real estate: A qualified appraisal by a licensed real property appraiser as of the date of death. For small estates that do not require a formal estate tax return, a comparable sales analysis or broker's price opinion may be sufficient for basis documentation purposes.
• Closely held business interests: A formal business valuation by a qualified business appraiser. This is often the most complex and expensive component of a large estate.
• Personal property (art, jewelry, collectibles): A qualified appraisal by an expert in the relevant category.

For estates large enough to file an estate tax return (Form 706), the values reported on that return establish the heir's basis. Heirs are required by law to use consistent values. The IRS requires executors to provide heirs with a statement (Form 8971) reporting the value used for estate tax purposes. IRS Form 706 instructions provide the detailed methodology for valuing estate assets.

Date of Death vs. Alternate Valuation Date

In most cases, the heir's stepped-up basis is the fair market value on the date of death. For estates large enough to owe federal estate tax, the executor may elect to use the "alternate valuation date," six months after death, if doing so reduces both the gross estate value and the federal estate tax liability.

The alternate valuation date election affects the heir's basis. If the executor elects alternate valuation, the heir's basis is the alternate valuation date value, not the date-of-death value. This can be useful when markets decline after death: a lower estate tax valuation also means a lower basis for the heirs, which is a trade-off that must be evaluated carefully.

For most estates, which fall well below the $15 million federal exclusion threshold in 2026, the alternate valuation date election is not available. It only applies to taxable estates.

Selling Inherited Property: Capital Gains Tax Treatment

Inherited assets are automatically treated as long-term capital assets for tax purposes, regardless of how long you actually hold them after inheriting. This matters because long-term capital gains rates (0%, 15%, or 20% depending on your income) are lower than short-term capital gains rates (taxed as ordinary income).

Even if you inherit an asset and sell it the next day, your gain is classified as long-term. This lets heirs sell inherited property without worrying about triggering higher short-term rates. For detailed guidance on selling inherited real estate, see our guide to selling inherited property. For broader guidance on how real estate and other property transfers work after a death, see our property transfer guide.

When calculating your gain, remember to also add the costs of selling (real estate commissions, transfer taxes, closing costs) to your basis. These selling costs reduce your taxable gain. For inherited property you improve before selling, the cost of improvements also increases your basis.

Keeping Good Records: Why Documentation Matters

For heirs who receive appreciated property, documenting the stepped-up basis is a must. If you sell inherited property years later and face an IRS audit, you need to prove what the fair market value was on the date of death. Keep the following:

• A copy of any estate tax return (Form 706) filed for the estate
• The Form 8971 and Schedule A if an estate tax return was filed
• Any appraisals of real property, business interests, or personal property
• Brokerage account statements or financial institution records showing values on the date of death
• The death certificate showing the date of death

Without documentation, you may not be able to prove your basis to the IRS, and all of your sale proceeds could be treated as gain. Use our inheritance calculator to estimate the tax implications of different scenarios before selling inherited assets.

Frequently Asked Questions