Step-Up in Basis on Joint Assets With a Non-Spouse: How It Works

When an individual passes away, the tax treatment of their jointly owned assets can significantly impact the surviving owner. A key factor in this process is the step-up in basis, which adjusts the asset’s value for tax purposes to its fair market value at the time of death. This adjustment can reduce capital gains taxes when the asset is eventually sold.

For joint owners who are not spouses, the portion of the asset that receives a step-up in basis depends on ownership percentages and financial contributions. Understanding these rules is necessary for accurate tax reporting and potential tax savings.

How Joint Ownership Affects Cost Basis

The way an asset is jointly owned influences how its cost basis is adjusted upon one owner’s death. The IRS recognizes different forms of joint ownership, such as joint tenancy with right of survivorship (JTWROS) and tenancy in common, each with distinct tax implications.

For JTWROS, the surviving owner automatically inherits the decedent’s share without probate. The IRS generally assumes equal ownership unless there is clear evidence showing otherwise. If two individuals jointly own a property, the default assumption is a 50/50 split, affecting how much of the asset’s value is eligible for a step-up in basis.

Tenancy in common allows each owner to hold a distinct, transferable share. When one owner dies, their portion is passed to their heirs or designated beneficiaries rather than automatically transferring to the co-owner. In this case, the surviving owner does not receive an automatic step-up unless they inherit the decedent’s share.

Determining the Decedent’s Share

To apply the step-up in basis correctly, the IRS considers financial contributions to determine ownership percentages. Whoever paid for the asset holds a proportionate share. Tracing the source of funds used for the purchase and ongoing expenses helps establish the decedent’s interest. Bank records, purchase agreements, and financial statements serve as primary evidence.

If contributions are not well-documented, the IRS may default to assuming equal ownership. This can create issues if one party contributed significantly more than the other. For example, if two individuals purchased a property together but one paid 80% of the cost while the other covered 20%, failing to provide proof of these contributions could result in an inaccurate tax basis adjustment. Keeping clear financial records is especially important for large assets.

For investment accounts, the decedent’s share is determined by the proportion of funds they contributed over time. If a brokerage account was funded entirely by one individual, their passing results in a full step-up in basis for their portion. If both owners contributed, each deposit must be reviewed to establish the decedent’s percentage. Reinvested dividends and capital gains distributions can complicate this calculation, requiring detailed records.

Allocating the New Basis

Once the decedent’s ownership percentage is established, the asset’s basis is adjusted accordingly. The portion attributed to the deceased receives a step-up to its fair market value as of the date of death, while the surviving owner’s share retains its original basis. This creates a split basis, which must be tracked for future tax purposes.

For real estate, this means recalculating depreciation if the property is used as a rental. The stepped-up portion follows a new depreciation schedule based on the updated value, while the surviving owner’s original share continues under the existing schedule. Depreciation recapture taxes apply when the property is sold, increasing the tax burden if not properly accounted for.

For securities, such as stocks or mutual funds, each security must be adjusted individually based on the decedent’s percentage. If the portfolio includes assets acquired at different times and prices, precise recordkeeping is necessary to ensure gains or losses are reported accurately.

Fair Market Value Documentation

Establishing the fair market value (FMV) of jointly owned assets at the time of death is necessary for correctly applying the step-up in basis and avoiding IRS disputes. The valuation method depends on the asset type.

For real estate, a professional appraisal is the most reliable way to determine FMV. IRS regulations require that the valuation reflect the price a willing buyer and seller would agree upon in an arms-length transaction. Comparable sales, market conditions, and unique property characteristics all influence the final valuation. If an appraisal is not conducted at the time of death, property tax assessments or automated valuation models may be used, though they carry a higher risk of IRS scrutiny.

For publicly traded securities, FMV is determined by averaging the highest and lowest trading prices on the date of death. If the market was closed that day, the average of the closest trading days is used.

Valuing a decedent’s interest in a privately held business is more complex. IRS guidelines consider factors such as earnings history, industry conditions, and comparable transactions. A formal business valuation from a certified appraiser is often required, especially when discounts for lack of marketability or minority ownership are applied. Failure to properly document these discounts can lead to IRS challenges, increasing taxable estate values and reducing the step-up benefit.

Reporting Requirements for Tax Filings

The surviving owner must accurately document the adjusted basis when filing future tax returns, particularly when the asset is sold. The reporting process varies depending on the asset type and whether an estate tax return is required.

For estates exceeding the federal estate tax exemption—$13.61 million in 2024—the executor must file Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return. This form includes a detailed inventory of the decedent’s assets and their fair market values at the date of death. Even if no estate tax is owed, filing Form 706 can provide a formal record of the stepped-up basis, which may help prevent IRS challenges later.

If the estate is below the exemption threshold, the surviving owner should still maintain thorough records, such as appraisals and brokerage statements, to substantiate the new basis when reporting capital gains.

When the asset is eventually sold, the adjusted basis must be reported on Schedule D of Form 1040, which calculates capital gains or losses. If the IRS questions the reported basis, the taxpayer may need to provide supporting documentation, such as the estate tax return, appraisal reports, or historical transaction records. Failure to properly substantiate the step-up in basis can result in additional taxes, interest, and penalties. If the IRS disputes the valuation, professional tax or legal assistance may be necessary to resolve the issue.