The Stepped-Up Cost Basis for Inherited Property

The "stepped-up cost basis" is one of the most significant and valuable tax provisions for people who inherit assets. It can eliminate capital gains taxes on decades of appreciation — representing a substantial tax benefit. Understanding how it works (and where it doesn't apply) is essential for heirs making decisions about inherited assets.

What Is Cost Basis?

When you own an asset — a stock, a piece of real estate, a piece of art — your "cost basis" is generally what you paid for it. When you sell the asset, you pay capital gains tax on the gain, which is the sale price minus the basis. The higher your basis, the lower your taxable gain.

Example: You buy 100 shares of XYZ at $10/share. Your basis is $1,000. If you later sell for $50/share ($5,000), your taxable gain is $4,000.

How Step-Up Works

When you inherit an asset, your cost basis is "stepped up" to the fair market value of the asset on the date of the previous owner's death — not the original purchase price. This resets any capital gains that accrued during the deceased person's lifetime.

Using the same example: If you inherited those 100 shares at the time they were worth $50/share, your basis is $5,000. If you sell for $52/share ($5,200), your taxable gain is only $200 — not $4,200.

If the shares had gone from $10 to $50 over 30 years, the step-up effectively eliminated the tax on $4,000 of gains per share. This is the power of the stepped-up basis.

What Assets Receive the Step-Up

The step-up applies to most capital assets inherited from a deceased person:

• Stocks, bonds, mutual funds, and ETFs held in taxable brokerage accounts
• Real estate (primary residences, investment properties, rental properties)
• Business interests
• Art, collectibles, and other capital assets
• Personal property with capital gain potential

What Does NOT Receive a Step-Up

Retirement accounts (IRAs, 401(k)s)

Inherited retirement accounts do NOT receive a stepped-up basis. Distributions from inherited IRAs and 401(k)s are taxed as ordinary income, just as they would have been to the original owner. This is because contributions to these accounts were pre-tax — the income was never taxed in the first place.

Gifts (assets received as gifts during the donor's lifetime)

Assets received as gifts during the donor's lifetime carry the donor's original basis (or, if lower, the fair market value at the date of the gift for loss purposes). This is a key distinction: receiving an asset as a gift before death vs. inheriting it after death has very different tax consequences.

If someone gives you appreciated stock while they're alive, you inherit their low basis. If you wait to inherit the same stock, you get a stepped-up basis. For heirs of elderly or terminally ill individuals, this distinction can be worth significant tax savings.

Step-Down Basis

The step-up also works in reverse — "step-down." If an asset has lost value since the deceased purchased it, the heir's basis is stepped down to the current fair market value. This can actually eliminate a potential loss deduction — inherited property has no carryover of the deceased's original loss.

Community Property States: Double Step-Up

In community property states, both halves of community property receive a stepped-up basis when one spouse dies — not just the deceased spouse's half. This is a significant additional benefit for surviving spouses in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin, and Alaska by election).

Example: A married couple purchased a home in California for $200,000. At the first spouse's death, the home is worth $800,000. In a community property state, the surviving spouse's basis in the entire property is stepped up to $800,000 — not just half. If the surviving spouse sells shortly after for $800,000, there is no capital gains tax.

Establishing the Stepped-Up Basis

To use the stepped-up basis, you need to know the fair market value of the asset on the date of death. For:

• Publicly traded securities: The average of the high and low trading prices on the date of death
• Real estate: A professional appraisal by a licensed appraiser as of the date of death
• Business interests, art, collectibles: A qualified appraisal by a specialist

Obtain appraisals promptly — it's easier to establish a date-of-death value close to the death than years later when memories and market evidence have faded.

For the complete taxes after death guide, see our taxes after a death guide. For how the step-up interacts with selling inherited property, see our article on capital gains tax when selling inherited property.