What Is a Step-Up in Basis and Why Does It Matter When You Inherit?

When you inherit a piece of real estate or a brokerage account, the tax basis of that asset is generally adjusted to its fair market value as of the date the original owner died. This adjustment, known as a step-up in basis, is one of the most significant tax benefits in the federal tax code for people who inherit appreciated assets. For appreciated assets, this adjustment can substantially reduce the capital gain recognized if the beneficiary later sells the asset, depending on its value at death, subsequent changes in value, and the applicable tax rules. Families who inherit property often have never heard of it, and some who have heard of it do not fully understand how it works or where it does not apply.

Understanding how basis works before selling, transferring, or making other decisions about inherited assets can help families avoid unexpected tax consequences. Here is how it works, why it matters, and where the rules are more complicated than they first appear.

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What the Step-Up in Basis Actually Is

Basis is the starting value used to calculate capital gains or losses when an asset is sold. If you buy stock for $10,000 and sell it for $40,000, your taxable capital gain is $30,000, because that is the difference between what you received and your basis of $10,000. The longer an asset is held, and the more it appreciates, the larger that taxable gain becomes when it is eventually sold.

Under Internal Revenue Code Section 1014, qualifying property acquired from a decedent generally receives a basis equal to its fair market value as of the date of death, subject to exceptions and alternative valuation rules. If your parent paid $200,000 for a house in 1990 and it was worth $800,000 when they died in 2024, your inherited basis in that house is $800,000, not $200,000. If you sell the house for $850,000, your taxable gain is $50,000, reflecting only the appreciation that occurred after the date of death. Without the step-up, that gain would have been $650,000, representing the entire appreciation during your parent’s lifetime.

The same principle applies to inherited securities. Stocks, mutual funds, and other investments that have appreciated significantly over an original owner’s lifetime receive a new basis at death. A beneficiary who sells those assets shortly after inheriting them may owe little or no capital gains tax, depending on how much the assets have changed in value since the date of death.

This adjustment applies regardless of whether the estate owes federal estate tax. Most estates are below the federal estate-tax filing threshold. For decedents dying in 2026, the federal basic exclusion amount is $15 million, although that amount is time-sensitive and should be confirmed for the applicable year. The step-up in basis is available to beneficiaries of smaller estates just as it is to beneficiaries of larger ones.

How the Step-Up Is Determined

The adjusted basis is generally the fair market value of the asset as of the date the original owner died. Establishing that value requires documentation, and the documentation required varies by asset type.

For publicly traded securities, fair market value is typically determined by the average of the high and low trading prices on the date of death, or by an alternate valuation method in limited circumstances. For real estate, a qualified retrospective appraisal is often used to establish fair market value as of the applicable valuation date. For closely held business interests, collectibles, or other assets that do not have a readily available market price, an independent appraisal by a qualified appraiser is generally required.

The estate’s executor is responsible for determining and documenting the fair market value of estate assets. The executor or other fiduciary may need to determine and document asset values for estate administration and tax purposes. Assets passing outside probate may still require reliable date-of-death valuation records, particularly when a beneficiary later needs to establish basis.

Keeping the documentation that establishes date-of-death value is important. If you later sell an inherited asset and cannot establish what its fair market value was at the date of the original owner’s death, the IRS may determine your basis using information it has, which may not reflect the true value at the time of inheritance. Working with the estate’s executor or a tax professional to obtain and preserve this documentation at the time of inheritance is worth the effort.

Where the Step-Up Does Not Apply

IRC Section 1014 generally applies to qualifying property acquired from or passing from a decedent. Some assets and arrangements are subject to different basis rules, so not every asset associated with an estate receives the same treatment. There are important categories where it does not apply, and understanding them is as important as understanding where it does.

Retirement accounts. Tax-deferred retirement accounts such as traditional IRAs and 401(k)s generally do not receive the same Section 1014 basis adjustment that applies to qualifying inherited capital assets. Distributions are generally subject to income-tax rules applicable to retirement accounts, including rules concerning previously untaxed amounts. Depending on the beneficiary and circumstances, inherited-account distribution requirements, including rules that may require distribution within a specified period, can also apply. This distinction is one reason why the tax planning involved in inheriting a retirement account differs from the planning involved in inheriting real estate or a brokerage account.

Assets transferred by gift during the owner’s lifetime. Property transferred by lifetime gift generally does not receive a date-of-death basis adjustment. Instead, the recipient generally takes a basis derived from the donor’s adjusted basis, subject to special rules, including different rules that may apply when the property’s fair market value at the time of the gift is below the donor’s adjusted basis. This distinction matters for planning decisions about whether to give appreciated assets during your lifetime or hold them and allow them to pass at death with a stepped-up basis. An asset with significant embedded gain that is given during life transfers that gain to the recipient. By contrast, if qualifying appreciated property is held until death and receives a basis adjustment under Section 1014, appreciation occurring before death may no longer be reflected in the beneficiary’s taxable gain when the property is later sold.

Property held in an irrevocable trust in certain circumstances. Assets held in certain irrevocable trusts may not receive a step-up in basis at the grantor’s death, depending on how the trust is structured and the applicable tax rules. This is a nuanced area where the specific terms of the trust and applicable law matter, and it is one reason why trust planning decisions should account for the long-term tax treatment of assets, not only the estate planning or Medicaid planning goals the trust was designed to serve.

Community property states. New Jersey and New York are not community property states, but this is worth noting for families with connections to states like California, Texas, or Arizona. In community property states, both halves of community property generally receive a step-up in basis at the death of either spouse, which can be a significant advantage compared to the rules in common law states like New Jersey and New York.

What This Means for Estate Planning Decisions Made Before Death

The step-up in basis is not only relevant to beneficiaries after an inheritance. It is relevant to the person doing the estate planning while they are alive, because the decision about how and when to transfer appreciated assets has real tax consequences for the people who will receive them.

Giving highly appreciated assets as gifts during your lifetime transfers your original basis to the recipient, who will owe capital gains tax on the full appreciation when they sell. Holding those same assets until death and passing them through your estate generally gives the recipient a stepped-up basis, eliminating the capital gain that accumulated during your lifetime. For families where the goal is to transfer appreciated real estate or securities to the next generation, the potential basis adjustment at death is an important factor to consider when deciding whether appreciated property should be transferred during life or retained until death. That decision should also account for estate and gift taxes, Medicaid and long-term care planning, creditor concerns, control, cash-flow needs, and the family’s broader objectives.

At the same time, assets that have declined in value since they were purchased present the opposite consideration. A step-down in basis at death would reduce the recipient’s loss on a future sale. In those situations, whether recognizing a loss during life would be advantageous depends on the type of asset, applicable loss-deduction rules, and the owner’s broader tax circumstances.

Trust planning also intersects with these rules in ways that deserve careful analysis. A revocable living trust generally does not affect the step-up in basis because the assets are still included in the grantor’s taxable estate at death. An irrevocable trust may remove assets from the taxable estate, which can have estate tax benefits but may also eliminate the step-up in basis for those assets. The trade-off between estate tax savings and capital gains tax on a future sale is a calculation that requires looking at both the estate’s size and the specific assets involved.

Plan Well. Live Better.

The step-up in basis is one of the most valuable provisions in the tax code for families transferring wealth across generations, and one of the most commonly misunderstood. At Milvidskiy Law Group, we help New Jersey families understand how their estate planning decisions interact with the tax treatment of inherited assets, so the people they leave behind do not pay taxes they were never meant to owe. Learn more about our estate planning services.

This article is for general informational purposes only and does not constitute legal or tax advice. Reading this article does not create an attorney-client relationship. Estate planning, tax, trust, Medicaid, and asset-protection strategies depend on individual circumstances and applicable law, which may change. Tax matters should be reviewed with qualified legal and tax professionals before action is taken.</p