When it comes to estate planning, the concept of a stepped-up basis can be a powerful tool for reducing capital gains taxes and preserving wealth for future generations. This provision allows heirs to reset the cost basis of inherited assets to their fair market value at the time of the original owner’s death, potentially saving thousands or even hundreds of thousands of dollars in tax liability. Whether you are planning your estate or expecting to inherit assets, understanding how the stepped-up basis works can help you make more informed financial decisions and maximize the value of inherited property.
What is stepped-up basis?
Let’s start with the cost basis. Typically, the cost basis of an asset equals the purchase price plus or minus any adjustments. In the case of real estate, the cost basis can increase when the owner makes substantial improvements or renovations or decreases with depreciation. Stock or mutual fund reinvestment, fees, or commissions you pay increase the cost basis.
According to Section 1014 of the Internal Revenue Code, when someone inherits property and investments, the fair market value of the assets steps up from the original owner’s cost basis to the fair market value on the date of the original owner’s death. This stepped-up basis allows heirs to reduce their capital gains taxes. Capital gains taxes are applied based on this reset value when the heir sells these assets. The result enables individuals to pass assets to their heirs with a much smaller tax liability.
Alternate Valuation Date
An alternate valuation option allows the executor of an estate to instead select six months after the date of death for valuing inherited assets, potentially reducing estate taxes.
The alternate valuation date can benefit estates with significant stock holdings if asset values have decreased since death. It allows the executor to lower the estate’s value if stock prices have declined in the six months following death.
Beware: If the alternate valuation date is chosen, it must be applied to all assets in the estate, not just selected ones. This decision can impact the estate tax liability and the stepped-up basis that heirs receive.
When you inherit an asset, you automatically qualify for long-term capital gains tax rates, regardless of the original owner’s holding period. These rates are more favorable compared to the higher short-term capital gain rates. See the 2025 chart below. The rate you pay depends on your taxable income.
Please note that capital gains on collectibles can be taxed up to 28%.
What assets are subject to a step-up in basis?
Assets that receive a step-up in basis when they pass to a beneficiary include:
- Real estate
- Individual stocks or bonds
- Mutual funds and exchange-traded funds
- Art and furnishings
- Collectibles
- Some business interests
Note: Assets such as the above passing to an heir from an irrevocable trust may not be eligible for a stepped-up cost basis.
What assets are not subject to step-up in basis?
Assets that do not receive a step-up in basis when they pass to a beneficiary include:
- Bank accounts
- Cash
- Certificates of deposit
- 401(k)s and other employer-sponsored retirement plans
- IRAs
- Pensions
- Annuities
You retain the original owner’s cost basis when you inherit one of these assets.
Example of a stepped-up cost basis
Suppose your mother bought a home in 1965 for $40,000 and passed away in 2025. In that 60 years, the home’s value increased to $750,000. The cost basis is adjusted to the home’s fair market value on the day of her passing, $750,000. Two years later, if you sell the house for $800,000, your capital gain is $50,000.
Without the step-up in cost basis, you would have inherited the home with a cost basis of $40,000. When you sold the house, the total capital gain would have been $710,000, or the difference between your mother’s purchase price ($40,000) and your sale price ($750,000).
For example, assuming you’re in the 15% federal capital gains rate bracket, you would owe about $106,500 in capital gains tax. With the step-up basis, the tax would have been $7,500, saving $99,000 in taxes.
We can apply the same situation to stock. Let’s say you’ve inherited 1,000 shares of XYZ stock that your Father bought in 1990 at $25 per share. His cost basis is 25,000.
ABC stock was $300 per share on the day your Father passed away. The stepped-up cost basis is $300,000 instead of $25,000.
Step-down Basis?????
Yes, there is the possiblity of receiving a step-down in basis. If your parent bought stock for $10,000, but at their passing, the fair market value is $8,000, your new basis is $8,000.
How does stepped-up basis work in community property states?
Residents of nine community property states can use a double step-up basis tax rule. Spouses have equal ownership of most income, assets, and debts acquired during marriage. However, in a separate property state, also known as a common law property state, spouses do not have equal claim over income or property acquired or earned solely in their partner’s name.
When one spouse dies in a community property state, the living spouse receives a significant tax benefit: A full step-up in basis on both ownership portions of all jointly owned assets. By contrast, a living spouse in a common law property state would only get a step-up in basis on the deceased partner’s portion of ownership.
For example, a couple purchased a home in California, a community property state, for $1,000,000. Ten years later, when the house is worth $1,500,000, one spouse dies. The surviving spouse’s new cost basis in the property is $1,500,000. What’s more, the property—if still owned by the surviving spouse upon their own death—can receive another step-up in basis when it passes to the next beneficiary.
Note: Some states allow community property trusts, letting married couples opt into community property treatment. These states are Alaska, Florida, Kentucky, South Dakota, and Tennessee.
How can I utilize the stepped-up basis in estate planning?
You can minimize taxes for your heirs by utilizing the step-up basis in your estate plan. Here are several ways to incorporate it:
Leave highly appreciated assets to heirs
Gifts of appreciated stock or real estate while the owner is still living typically retain the owner’s cost basis. If, instead, the asset is transferred upon the owner’s death, it receives a stepped-up basis, and the recipient is never taxed on the capital gain accrued during the original ownership period. If your grandchildren inherit your stock portfolio, they will receive it at the fair market value on the date of your death. If, instead, you gift it to them while you’re still living, they will assume your cost basis and be subject to a much more significant capital gain and subsequent tax bill when they sell the asset.
Gifting Real Estate
We are often asked about gifting children real estate. Parents want to gift their homes or other real estate holdings while they are alive so the real estate won’t have to go through the hassles of probate upon their death. The problem is that they lose the stepped-up basis if they do so. See the previously mentioned example.
By creating a revocable trust for their real estate, parents can avoid probate and retain the step-up for their heirs. Upon death, the trustees take control of the house without going through probate and won’t owe taxes on the original cost basis.
Philanthropic Wishes
Suppose you want to gift highly appreciated assets rather than cash to fulfill philanthropic goals. In that case, the charity will not pay capital gains taxes when disposing of the donated asset. Within certain limits, the donor will receive an immediate income tax deduction of the fair market value of the contribution, and the asset and any future appreciation will be removed from their estate. Many individuals will do this via a donor-advised fund during their lifetime.
Whether to donate your highly appreciated assets or pass them on to your heirs at the time of your passing depends on your goals and your and your heirs’ situation.
Bottom Line
Understanding how the stepped-up basis applies to your or your heir’s situation allows you to consider your estate planning decisions. Consider working with an attorney and CERTIFIED FINANCIAL PLANNER®, professional to fully realize your tax savings opportunities while maximizing your inherited assets.
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