Step-Up in Basis
Tax rule resetting an inherited asset's cost basis to fair market value at the decedent's date of death.
Step-up in basis is an income tax provision under IRC Section 1014 that resets the cost basis of an inherited asset to its fair market value on the date of the decedent's death (or, if elected, six months later under the alternate valuation date). This reset—or 'step-up'—eliminates any capital gains that accrued during the decedent's lifetime, potentially saving heirs substantial income taxes upon eventual sale.
Consider a stock purchased for $10,000 that grows to $500,000 at death. Without step-up, an heir selling the stock would owe capital gains tax on $490,000 of gain. With step-up, the heir's basis becomes $500,000—the fair market value at death—so selling immediately triggers zero capital gains. The $490,000 of economic gain permanently escapes capital gains taxation.
Step-up in basis applies to most capital assets held directly or through certain trusts, including stocks, bonds, real estate, business interests, and collectibles. Assets held in IRAs and other tax-deferred retirement accounts do not receive a step-up—they remain fully taxable as ordinary income when withdrawn by beneficiaries.
For real estate investors who have used 1031 exchanges to defer gains across multiple properties, step-up at death can permanently eliminate all accumulated deferred gains—a strategy sometimes called the 'buy, borrow, die' approach to wealth building.
Political debate surrounds step-up in basis. Critics argue it is a major mechanism of wealth concentration, allowing dynasties to transfer appreciated assets without ever paying capital gains. Proposals to eliminate or modify step-up periodically emerge in tax reform debates but have not been enacted at the federal level as of mid-2025.
FAQs
Does step-up in basis apply to assets held in a trust?
It depends on the trust type. Assets in a revocable living trust receive a full step-up at the grantor's death because the assets are considered part of the taxable estate. Assets in an irrevocable trust generally do not receive a step-up if they are outside the taxable estate—they retain the original carryover basis. Certain intentionally defective grantor trusts (IDGTs) and other planning structures are specifically designed to retain estate inclusion (and thus step-up) while achieving other transfer tax benefits.
What is a step-down in basis, and when does it occur?
A step-down occurs when an asset's fair market value at the decedent's death is lower than the original cost basis. Under IRC Section 1014, the heir's basis is stepped down to fair market value, meaning the built-in loss is permanently forfeited—heirs cannot claim the economic decline in value. To preserve losses in declining assets, advisors often recommend selling such assets before death so the owner can recognize and use the capital loss on their own tax return rather than passing an unrealized loss to heirs who cannot benefit from it.
How does step-up in basis interact with the estate tax?
Step-up in basis and estate tax often apply to the same assets but are separate tax systems. An estate may owe federal estate tax on the value of assets above the exemption threshold (over $12 million in 2024), while the same assets receive an income tax step-up in basis for capital gains purposes. The two taxes are not mutually exclusive. For very large estates, paying estate tax does not prevent the step-up—heirs both owe estate tax and receive a basis adjustment to fair market value on the same inherited assets.
Related Terms
Like-Kind Exchange
Tax-deferred swap of investment real estate for similar property under IRS Section 1031.
Estate Planning
The process of arranging for the management and distribution of assets during life and after death, minimizing taxes and ensuring wishes are carried out.
Estate Tax
Federal tax on the transfer of assets from a decedent's estate above a statutory exemption threshold.
Beneficiary Designation
A legal instruction naming who receives specific account assets directly upon the account holder's death, bypassing probate.
