Step-Up in Basis: How Inherited Assets Lose Their Capital Gains

By Tom, CPA · Updated October 27, 2026

Part of: Tax Planning

TL;DR: When you die, most assets you own get a new tax basis equal to their value at death, so heirs can sell with little or no capital gains tax. Retirement accounts do not get a step-up. In community property states, both halves of a couple's community property step up at the first death. Gifts during life keep the old basis.

Educational only, not tax, legal, or investment advice. Examples are illustrations, not predictions. Rules and limits change; verify current figures and talk to a qualified professional about your situation.

Under Section 1014 of the tax code, the basis of property acquired from a decedent is generally its fair market value at the date of death. Decades of unrealized gains on stock, a home or a rental property simply disappear for income tax purposes. It is one of the most valuable tax breaks in the code, and it requires nothing except holding assets until death, which most people manage without help.

Because it is passive, people rarely plan for it. But choosing which assets to spend, which to give away and which to hold can save heirs a large amount of tax. This guide covers how the step-up works, community property, which assets to hold, gifting versus inheriting and an example. Rules are current as of October 27, 2026, from 26 U.S.C. 1014 and IRS Publication 551. Related: estate tax basics and capital gains planning.

CPA Warning Label: Step-up in basis is the tax code's way of saying all is forgiven, but only for capital gains, only at death, and never for your IRA. Timing, as they say, is everything.

How step-up works

• The heir's basis equals fair market value at the date of death (or the alternate valuation date six months later, if the executor elects it for a taxable estate and it lowers both the estate and the tax).
• Heirs automatically get long-term holding period treatment, even if they sell the next day.
• If the asset has lost value, basis steps down to market value, and the loss is gone. Losers are better sold during life.
• Depreciated rental property gets a full step-up, wiping out both the gain and the depreciation recapture the owner would have owed. See rental basis.
• Property received through a 1031 exchange chain also steps up, which is why "swap till you drop" is a real strategy.

What does not step up

• Traditional IRAs, 401(k)s, annuities and other "income in respect of a decedent" (IRD). Heirs pay ordinary income tax on withdrawals.
• Roth IRAs do not need one: qualified withdrawals are tax-free anyway.
• Assets in most irrevocable trusts that are not included in the estate.
• Property gifted to the decedent within one year of death and passing back to the original giver (Section 1014(e)).

Documentation matters. The executor or heir should get date-of-death values: brokerage statements for securities, an appraisal for real estate and closely held businesses. For estates that file Form 706, basis consistency rules require heirs to use the values reported on the estate tax return.

Community property double step-up

In community property states, community property held by a married couple gets a full step-up on both halves at the first spouse's death, under Section 1014(b)(6). In common-law states, only the deceased spouse's half of jointly held property steps up.

Selling right after the first death, the survivor in the common-law state has a $400,000 gain; the survivor in the community property state has none. A few states also allow couples to elect community property treatment through a special trust; whether that achieves the federal double step-up for people living outside a traditional community property state is a developing and debated area.

Moving between states? Property generally keeps the character it had where it was acquired, so a couple who moves from a community property state may still hold community property. Records matter.

Which assets to hold

For a retiree spending down a portfolio, every asset falls into one of three groups:

• Spend first: cash, high-basis assets, and assets with losses (sell to harvest the loss). These have little or no gain to forgive.
• Spend or convert strategically: traditional IRAs and 401(k)s. They get no step-up, and non-spouse heirs usually must empty them within 10 years. Drawing them down or converting to Roth in low-bracket years often saves heirs more than leaving them.
• Hold until death: low-basis stock, long-held funds, depreciated rentals and a home with gain above the home sale exclusion.

This ordering conflicts with standard withdrawal advice, which often says taxable accounts first. For older retirees with large unrealized gains and heirs in mind, keeping the lowest-basis lots and spending others can be worth more. Use specific lot identification to pick which lots to sell.

Charitable gifts fit too: give the lowest-basis shares to charity, which wipes out the gain without waiting for death, and keep moderate-basis shares for heirs.

Gifting vs inheriting

Gifts during life take the giver's basis (carryover basis). Inheritances get a step-up. That single difference drives a lot of planning:

• Give cash or high-basis assets while living; leave low-basis assets at death.
• Do not gift a highly appreciated rental to a child to "get it out of the estate" unless the estate is above the $15 million exemption. The child inherits your low basis and the recapture, and loses the step-up.
• Adding a child to the deed of a house during life is a gift of half, with carryover basis on that half.
• Selling to a child at a bargain price creates a part-gift, part-sale with complicated basis rules.

See the gift tax annual exclusion guide for the gifting side.

Rental property and the step-up

Real estate investors get the most dramatic benefit. Consider a rental bought for $300,000 that has been depreciated by $200,000 and is now worth $900,000. A sale during life produces $800,000 of gain, with $200,000 taxed as unrecaptured Section 1250 gain at up to 25% and the rest at capital gains rates, plus possibly 3.8% net investment income tax. At death, the heir's basis becomes $900,000, the recapture disappears, and the heir can start depreciating the building again based on its new value.

That is why many investors use 1031 exchanges to defer gains during life and then hold the final property until death. It works under current law, but the chain must be documented, and the investor needs liquidity, because a portfolio of rentals is hard to spend.

Planning moves late in life

• Avoid selling low-basis assets in the last years of life unless the money is needed. Borrowing against a portfolio or home can bridge a cash need while keeping the step-up, though it adds interest cost and risk.
• Harvest losses before death. Unused capital loss carryforwards die with the taxpayer (on a joint return, the deceased spouse's share disappears after the final return).
• Review titling. In community property states, holding assets as community property rather than joint tenancy can preserve the double step-up.
• Keep records of values at death. An appraisal done years later is weaker evidence.
• Coordinate with heirs' brackets. Heirs in high brackets benefit more from stepped-up assets and less from inherited IRAs.

None of this requires exotic structures. It mostly requires a list of which assets have big gains and a decision not to sell them.

Example

Illustration

Ruth, 84, widowed, lives in a common-law state with $2 million: a $600,000 IRA, a $400,000 house (basis $150,000), $700,000 of index funds bought in the 1990s (basis $100,000), and $300,000 of recently bought bonds (basis about $300,000).

• She needs $60,000 a year beyond Social Security. Spending from bonds and IRA withdrawals keeps the old index funds untouched.
• She gives $20,000 a year to charity using QCDs from her IRA, satisfying part of her RMD.
• At her death, her children inherit the index funds and house at full value. The $600,000 of gain on the funds disappears. (The house's $250,000 gain would likely have been covered by her $250,000 home sale exclusion anyway, so the step-up mostly saves paperwork there.) At 15% plus 3.8% net investment income tax, the funds alone are roughly $113,000 of tax avoided.
• Had she gifted the index funds five years earlier, her children would carry her $100,000 basis.

Illustration only. Step-up rules are law today, but proposals to limit them have appeared in past budget debates; none were enacted as of this writing.