What Is Step-Up in Basis?
In plain English
Step-up in basis is a tax provision that adjusts the cost basis of an inherited asset to its fair market value at the date of the owner's death. This means all capital gains that accumulated during the deceased owner's lifetime are effectively erased for tax purposes. When the heir eventually sells the asset, they only owe capital gains tax on appreciation that occurs after they inherit it.
How Does Step-Up in Basis Work?
Suppose your parent bought stock for $50,000 that grew to $500,000 by the time they died. Without step-up, selling would trigger $450,000 in capital gains. With step-up, your new basis becomes $500,000 — the value at death. If you sell immediately, you owe zero capital gains tax. If you hold and sell later at $550,000, you only pay tax on the $50,000 gain since inheritance. Step-up applies to stocks, real estate, businesses, and most other appreciated assets.
How Does Step-Up Apply to Different Property Types?
For individually owned property, the entire asset receives a full step-up. For joint tenancy between non-spouses, only the deceased's share (typically 50%) gets stepped up. For community property, both halves receive a full step-up — a significant tax advantage unique to community property states. For property in a revocable trust, step-up applies normally. Property in an irrevocable trust may or may not receive step-up depending on the trust structure.
Why Is Step-Up in Basis Controversial?
Critics argue step-up in basis primarily benefits wealthy families, allowing billions in capital gains to permanently escape taxation. When heirs receive stepped-up assets and hold until their own death, the next generation receives another step-up — creating a perpetual tax avoidance cycle. Proposals to eliminate or limit step-up regularly appear in tax reform discussions. Supporters counter that step-up prevents forced sales of family farms and businesses to pay taxes on unrealized, paper gains.
Frequently asked questions
Does step-up in basis apply to gifted assets?
No. Gifted assets receive a 'carryover basis' — the recipient inherits the original owner's cost basis. This is a critical distinction: it's often more tax-efficient to hold appreciated assets until death (getting a step-up) rather than gifting them during life (carrying over the low basis).
Does step-up in basis apply to retirement accounts?
No. IRAs, 401(k)s, and other tax-deferred retirement accounts do not receive a step-up in basis. Inherited retirement account distributions are taxed as ordinary income to the beneficiary. This is because contributions were tax-deferred, so the tax was never paid in the first place.
Can basis step down at death?
Yes. If an asset has declined in value, the basis adjusts to the lower fair market value at death — a 'step-down.' This means the heir cannot claim a loss on the difference between the original purchase price and the death date value. Selling depreciated assets before death can be more tax-efficient.
Keep exploring
Related terms
Capital Gains Tax
Capital gains tax applies to profits from selling assets like stocks, real estate, or collectibles. The rate depends on how long you held the asset and your total income.
Community Property
Community property is a legal system in some US states where most assets and debts acquired during marriage are owned equally by both spouses.
Inheritance Tax
An inheritance tax is a state-level tax paid by the person who receives assets from a deceased person's estate, based on the value of the inheritance.
Estate Tax
The federal estate tax applies to the transfer of wealth from a deceased person's estate to heirs when the estate's value exceeds a high exemption threshold. Most estates owe no federal estate tax.
Transfer on Death (TOD)
A transfer on death designation allows investment and brokerage account assets to pass directly to named beneficiaries upon the owner's death, bypassing probate.