Does an Estate Get a Stepped-Up Basis for Assets?

When someone passes away, their assets may receive a step-up in basis, a tax provision that adjusts an asset’s cost basis to its fair market value at the time of death. This rule reduces capital gains taxes for heirs and plays a key role in estate planning.

Conditions for a Step-Up in Basis

For an asset to qualify, it must be part of the decedent’s taxable estate. Individually owned assets and those in revocable trusts typically qualify, while assets transferred before death do not.

The step-up is based on fair market value (FMV) at the date of death unless the estate elects an alternate valuation date—six months later—if it lowers both the gross estate value and estate tax liability. Executors must assess whether this election provides a tax advantage.

Jointly owned property complicates the calculation. In joint tenancy or tenancy by the entirety, only the deceased’s portion receives a step-up. In community property states, the entire asset may qualify, offering greater benefits to a surviving spouse.

Common Properties That Qualify

Assets that typically qualify include real estate, stocks, bonds, mutual funds, and business interests. These assets often appreciate, making the step-up valuable in reducing capital gains taxes. If a stock purchased for $10 per share is worth $100 at death, the heir’s cost basis resets to $100, eliminating taxable gain on past appreciation.

Privately held business interests, such as shares in an S corporation or a partnership, may also qualify. However, valuation can be complex due to factors like minority discounts or lack of marketability. The IRS closely examines these valuations, and professional appraisals help ensure compliance.

Taxable brokerage accounts benefit from the step-up, while retirement accounts, including IRAs and 401(k)s, do not. Inherited retirement accounts are subject to required minimum distributions (RMDs) and ordinary income tax upon withdrawal, whereas stocks and bonds in a taxable account can be sold immediately without capital gains tax.

Determining the Fair Market Value

Establishing FMV is essential for applying the step-up in basis. The IRS defines FMV as the price a willing buyer and seller would agree upon in an open market. Accurate valuation prevents disputes and ensures compliance with tax laws.

For publicly traded securities, FMV is based on the average of the high and low trading prices on the date of death. If markets were closed that day, the nearest trading day’s prices are used.

Real estate requires a professional appraisal, factoring in comparable sales, property condition, and market trends. If the estate files Form 706 (United States Estate Tax Return), the reported FMV must align with IRS standards to avoid audit risks.

Specialized appraisals are necessary for collectibles, intellectual property, or closely held business interests. The IRS scrutinizes these valuations, especially for unique assets without an active market. Revenue Ruling 59-60 provides guidance on valuing closely held stock, considering financial performance, industry conditions, and goodwill.

Capital Gains Considerations

When an heir sells an inherited asset, capital gains tax applies only to appreciation beyond the stepped-up basis, eliminating decades of unrealized gains from taxation. If the asset is sold soon after inheritance, taxable gain may be minimal or nonexistent.

Inherited assets are automatically classified as long-term holdings, ensuring any taxable gain is subject to preferential long-term capital gains tax rates of 0%, 15%, or 20%, depending on the heir’s income level. This differs from short-term capital gains, which are taxed at higher ordinary income rates.

For heirs who hold assets for years, future appreciation will be taxable upon sale. Tax planning strategies, such as gifting appreciated assets to lower-income family members or donating to charity, can help reduce tax burdens.

Assets That Do Not Get a Step-Up

Certain assets do not qualify for a step-up in basis. Understanding these exclusions helps heirs plan for potential tax liabilities.

Retirement accounts like traditional IRAs, 401(k)s, and annuities retain their original cost basis, meaning withdrawals are taxed as ordinary income. Roth IRAs also do not receive a step-up, though qualified withdrawals remain tax-free.

Assets transferred through irrevocable trusts before death generally do not qualify, as they are no longer part of the decedent’s taxable estate. Similarly, lifetime gifts retain the original cost basis, potentially resulting in higher capital gains taxes when sold. This distinction is important when deciding between gifting assets or allowing them to pass through inheritance.

Estate Tax Interplay

The step-up in basis affects estate and capital gains taxes. While it reduces capital gains exposure for heirs, estate taxes apply to the total value of inherited assets.

As of 2024, the federal estate tax exemption is $13.61 million per individual, meaning estates below this threshold owe no federal estate taxes. For estates exceeding this amount, tax rates range from 18% to 40%. Some states impose their own estate or inheritance taxes with lower exemption limits, making state rules an important consideration.

For taxable estates, strategies such as gifting assets during life, using valuation discounts, or establishing grantor-retained annuity trusts (GRATs) can help minimize exposure. Electing the alternate valuation date can also reduce estate tax liability if asset values decline after death. Coordinating estate and income tax planning ensures heirs maximize financial benefits while complying with tax laws.