When someone passes away and leaves assets to heirs, the recipients often receive a valuable but sometimes misunderstood tax benefit known as the step-up in basis. This rule can significantly reduce capital gains taxes for the beneficiary and is also an important consideration in estate planning.

What Is Basis?

Basis is generally the original value of an asset for tax purposes, usually what the owner paid for it, adjusted for improvements, depreciation, or return of capital. When you sell an asset, your capital gain (or loss) is the sale price minus the basis.

For example, if you bought stock for $10,000 and sold it for $50,000, your capital gain is $40,000. If the asset is held for more than one year, the gain is typically taxed at favorable long-term capital gains rates (up to 20% for high-income earners).

How the Stepped-Up Basis Works

When someone dies, many capital assets (stocks, real estate, business interests, artwork, cryptocurrency, etc.) receive a step-up (or step-down) in basis to their fair market value (FMV) as of the date of death (or, if elected by the executor, the alternate valuation date six months later). This means that appreciation during the decedent’s lifetime is not taxed. The beneficiary only pays capital gains tax on any increase in value after the date of death.

For Example: Dan bought XYZ stock for $100,000. At his death, it’s worth $500,000. His daughter Alice inherits the stock with a basis of $500,000. If she later sells it for $700,000, she only pays capital gains tax on the $200,000 increase since Dan’s death.

Without the step-up, Alice would have owed tax on the entire $600,000 gain.

What Assets Qualify?

Assets that typically qualify for stepped-up basis include:

  • Stocks and investment accounts
  • Real estate
  • Business interests
  • Artwork and collectibles
  • Personal property

Assets not eligible for a stepped-up basis include:

  • Traditional and Roth IRAs
  • 401(k) plans and other qualified retirement accounts
  • Annuities with income-in-respect-of-a-decedent (IRD) components

These accounts are usually taxed as ordinary income when inherited.

What Happens if the Asset Has Lost Value?

If an inherited asset is worth less than the decedent’s original basis, the basis is stepped down to the lower FMV at the date of death. If the value increases after death and the heir sells at a gain, that gain is taxable. Conversely, if the value continues to decline, a capital loss may be recognized upon sale.

Action Steps for Heirs

If you’ve inherited assets:

  • Document the FMV of each asset as of the date of death using brokerage statements, appraisals, or reputable online tools (e.g., Zillow for real estate).
  • Retitle inherited assets into your name or trust promptly to avoid legal and administrative issues.
  • Maintain thorough records of all inherited assets and FMV documentation. The IRS may inquire even years later, especially if the asset is sold long after inheritance.

Action Steps for Individuals Planning Their Estates

If you’re managing your estate or helping a client plan:

  • Inventory low-basis assets that you plan to retain and leave to heirs. Holding rather than gifting can help avoid triggering capital gains tax during your lifetime.
  • Harvest capital losses to offset gains that can’t be eliminated through a step-up.
  • Coordinate gifts and bequests carefully. Remember that gifts made during life generally pass on a carryover basis, the recipient takes on your original basis. In contrast, inherited assets receive a step-up.

Note: Gifts made shortly before death (so-called “deathbed gifts”) may still be included in the gross estate and eligible for a step-up in basis, depending on the timing and nature of the transfer.

Estate Tax Considerations

For 2025, the federal estate and gift tax exemption is $13.99 million per person. Most estates fall below this threshold and won’t owe federal estate tax. However, state estate taxes may still apply, and capital gains taxes on inherited assets remain a consideration for beneficiaries.

Final Thoughts

Understanding and planning around the stepped-up basis rules can significantly affect the financial outcome for your heirs. Whether you’re administering an estate or planning one, proactive strategies, combined with good recordkeeping, can ensure a smooth transition and minimize unnecessary taxes.

DWC CPAs and Advisors have expertise with estate, trust, and gift tax planning. We can collaborate with your estate attorney to tailor these strategies to your specific situation or give us call if you have recently inherited assets and need help with a tax mitigation strategy.