Step-Up in Basis: The Quiet Engine of Inheritance Planning

The mechanism

Income tax on an investment is charged on the gain — the difference between what you sell it for and your basis, usually what you paid. When property passes from someone who has died, the heir’s basis is reset to the property’s fair market value on the date of death (IRC § 1014). If a parent bought stock for $50,000 that is worth $500,000 at death, the child’s basis becomes $500,000 — and the $450,000 of lifetime gain simply vanishes for income-tax purposes. Sell it the next day for $500,000 and there is no taxable gain at all.

This page uses “basis adjustment at death” as the primary term; “step-up” is common shorthand, but the adjustment may be upward or downward. Property acquired from or passed from a decedent within IRC § 1014(b) generally takes basis equal to fair market value at death, or the value determined under a valid alternate-valuation election. Gross-estate inclusion is relevant but is not, by itself, a complete statement of every § 1014 category.

What gets the basis adjustment

The adjustment applies to property “acquired from or passed from a decedent” within the categories of IRC § 1014(b) — which include property acquired by bequest, devise, or inheritance, and certain property included in the decedent’s gross estate. That is a wide net: assets held outright, assets in a revocable living trust (included in the estate under IRC § 2038), and most jointly held and inherited property. It is not universal, though. Assets a person gave away into an irrevocable trust during life, and thereby removed from their estate, generally get no adjustment — the IRS confirmed as much for irrevocable grantor trusts in Rev. Rul. 2023-2, which we cover in the trust-funding mistakes page. Gross-estate inclusion is relevant, but whether property falls within a § 1014(b) category — often, but not always, through that inclusion — is what determines the adjustment.

The community-property double step-up

Married couples in community-property states get a notable advantage. When one spouse dies, both halves of the couple’s community property receive a new basis — not just the deceased spouse’s half (IRC § 1014(b)(6)). More generally, for jointly owned property the adjusted portion depends on the form of ownership, the parties’ contributions, the spouse rules in IRC § 2040, and state community-property law. In qualifying community-property cases, both halves may receive a basis adjustment; in other joint-tenancy cases, the includible portion may be more or less than one-half. For a couple with a highly appreciated asset in a community-property state, the “double step-up” can erase the entire gain at the first death rather than only half of it — a meaningful, and frequently overlooked, planning point.

What the basis adjustment doesn’t reach

The adjustment has real limits, and missing them leads to unpleasant surprises. Income in respect of a decedent does not receive a § 1014 basis adjustment; IRC § 1014(e) can deny an adjustment when appreciated property is given to a decedent and returns to the donor within one year; and alternate valuation under § 2032 and special-use valuation under § 2032A can also change the basis result.

• Income in respect of a decedent (IRD). Assets holding untaxed ordinary income — traditional IRAs and 401(k)s, deferred-annuity gains, unpaid deferred compensation, savings-bond interest — get no basis adjustment. Section 1014 expressly excludes a right to receive IRD (IRC § 1014(c)), so the heir pays ordinary income tax as the money comes out.
• The one-year gift-back rule (§ 1014(e)). IRC § 1014(e) denies a basis adjustment when appreciated property is given to a decedent and passes back to the donor (or the donor’s spouse) within one year of the gift.
• Gifted assets. Property given away during life carries the giver’s basis (IRC § 1015) rather than being adjusted — the core of the gifting-versus-inheriting decision.
• The alternate valuation date. An estate may in some cases elect to value assets six months after death rather than on the date of death (IRC § 2032); the elected value then sets the basis. It is an estate-level election, not an automatic feature.
• Special-use valuation (§ 2032A). For qualifying farm and closely held business real property, an estate may elect special-use valuation under IRC § 2032A, which can change the value that sets the basis.

Why it can beat the estate tax

For an estate comfortably under the $15 million exclusion, there is no estate tax to avoid — so the planning goal flips from shrinking the estate to keeping assets in it to capture the step-up. Giving a low-basis asset away during life removes it from the estate but forfeits the step-up, handing the recipient a built-in capital-gains bill for a tax the family would never have owed. That trade-off is the single most common wealth-transfer mistake among families below the exemption, and the reason the next page exists.

Sources & methodology