Step-up in Basis

What is Step-up in Basis?

A step-up in basis is a federal income-tax rule that generally changes the basis of inherited property to its fair market value on the applicable valuation date. If the property has declined in value, the same rule can produce a step-down in basis.

Under IRC Section 1014, qualifying property acquired from a decedent generally receives a basis equal to its fair market value on the date of death. 

An alternate valuation, special-use valuation, or statutory exception may change that amount.

The stepped-up basis affects the beneficiary’s taxable gain or loss when the property is sold. It can also affect depreciation when inherited property is used for business or rental purposes.

For a broader explanation of how basis changes during ownership, see CPA Pilot’s guide to tax basis versus adjusted basis.

Scope: This page addresses U.S. federal tax rules. State property, probate, community-property, estate-tax, and inheritance-tax rules may differ.

How does step-up in basis work?

Step-up in basis replaces the decedent’s adjusted basis with the property’s fair market value on the applicable valuation date.

Step-up in basis example

A parent purchased stock for $40,000. The stock was worth $150,000 when the parent died.

If the beneficiary sells the stock for $155,000, the gain is generally $5,000 before transaction costs.

$155,000 sale proceeds − $150,000 stepped-up basis = $5,000 gain

The $110,000 of appreciation during the parent’s lifetime is not included in the beneficiary’s capital gain.

A step-up in basis is not a deduction, tax credit, or exclusion. It establishes a new starting basis for qualifying inherited property.

How is Stepped-up Basis Calculated?

The stepped-up basis is generally the property’s fair market value on the applicable valuation date.

The calculation follows three steps:

1. Determine whether the property qualifies under Section 1014.

2. Establish its fair market value on the applicable valuation date.

3. Apply any increases or decreases occurring after that date.

The IRS guidance for survivors, executors, and administrators explains how beneficiaries determine inherited-property basis.

Stepped-up basis formula

Fair market value on the applicable valuation date + later basis increases − later basis decreases = adjusted inherited basis

Later increases may include qualifying capital improvements. Later decreases may include depreciation allowed or allowable, casualty-related adjustments, and certain reimbursements.

How Is Fair Market Value Determined for Step-Up in Basis? 

Fair market value is generally the price at which property would change hands between a willing buyer and willing seller when neither is required to act, and both understand the relevant facts.

The appropriate valuation evidence depends on the asset.

A property-tax assessment or informal online estimate may not reliably establish federal income-tax basis.

What Is the Valuation Date for Step-Up in Basis? 

The applicable valuation date is generally the date of death. However, an alternate valuation may apply when the executor makes a valid election.

Under IRC Section 2032, the executor may elect alternate valuation only when the election reduces both:

• The value of the gross estate, and

• The combined federal estate-tax and generation-skipping transfer-tax liability, after allowable credits.

When elected:

• Property retained by the estate is generally valued six months after death.

• Property sold, exchanged, distributed, or otherwise disposed of within six months is generally valued on the disposition date.

• The election applies to all property included in the gross estate, not selected assets.

• A beneficiary cannot independently choose an alternate valuation.

• The election is generally irrevocable once made.

The Instructions for Form 706 explain the election requirements.

A valid Section 2032A special-use valuation election can value qualifying farm or closely held business real estate according to its qualified use rather than its highest and best use. That can reduce both the estate-tax value and the beneficiary’s starting basis.

Can inherited property receive a step-down in basis?

Yes. A step-down occurs when the property’s fair market value on the applicable valuation date is below the decedent’s adjusted basis.

A decedent purchased stock for $75,000. It was worth $50,000 on the date of death.

The beneficiary generally uses the lower $50,000 basis. The decedent’s higher basis does not carry over.

Which assets receive a step-up in basis?

Qualifying property acquired from a decedent, including capital, investment, and business property, may receive a step-up or step-down in basis.

Eligibility depends on how the property was owned, transferred, and treated for federal estate-tax purposes. Receiving possession of an asset after someone dies does not automatically establish that it qualifies.

Which assets do not receive a standard step-up in basis?

Certain assets and income items do not receive a conventional Section 1014 adjustment.

Income in respect of a decedent, commonly called IRD, is generally reported by the estate or beneficiary when received rather than receiving a standard basis adjustment.

Installment-sale obligations are generally treated as IRD. Future payments can retain the decedent’s unrecognized income character instead of receiving a standard fair-market-value basis adjustment.

IRS Publication 559 explains the applicable income and basis rules.

How does step-up in basis affect capital gains tax?

Step-up in basis generally removes pre-death appreciation from the beneficiary’s capital-gain calculation. The beneficiary can still recognize gain on appreciation occurring after the applicable valuation date.

Capital Gains Formula With a Step-Up in Basis 

Amount realized − adjusted stepped-up basis = gain or loss

Suppose inherited property has a stepped-up basis of $400,000. The beneficiary later sells it for $440,000 and pays $20,000 in selling expenses.

Qualifying inherited capital assets generally receive long-term holding-period treatment, regardless of how long the beneficiary personally owned them.

Investment sales are commonly reported on Form 8949 and Schedule D. Sales of rental or business property may require Form 4797.

Long-term treatment does not make every gain a capital gain. Depreciation recapture and other tax-character rules may still apply.

How does step-up in basis apply to inherited real estate?

Inherited real estate generally receives a stepped-up basis equal to its fair market value on the applicable valuation date. A retrospective appraisal is often the strongest evidence supporting that value.

Step-Up in Basis Example for Inherited Real Estate 

A property is worth $500,000 on the date of death. The beneficiary later spends $25,000 on qualifying capital improvements and sells the property for $560,000. Selling expenses are $30,000.

The decedent’s original purchase price and pre-death improvements are not added again. They were part of the old adjusted basis that the inherited value replaced.

The IRS provides additional guidance on inherited homes in Publication 530, Tax Information for Homeowners.

Can You Depreciate Inherited Rental Property After a Step-Up in Basis? 

Yes. A beneficiary may depreciate inherited real estate when it is used in a rental activity or another income-producing activity.

The stepped-up basis must be allocated between:

• Nondepreciable land, and

• Depreciable buildings or improvements.

For example, an inherited rental property is valued at $600,000. A qualified valuation allocates $150,000 to land and $450,000 to the building.

The beneficiary generally begins a new depreciation schedule for the inherited building basis using MACRS when the property is placed in service. IRS Publication 527 explains depreciation of residential rental property.

How Does Step-Up in Basis Work for Inherited Stocks? 

The stepped-up basis of inherited publicly traded stock is generally its fair market value on the applicable valuation date.

The beneficiary should retain:

• Estate valuation statements

• Date-of-death brokerage statements

• Form 706 schedules, when applicable

• Schedule A of Form 8971, when applicable

• Records of later purchases, sales, and reinvested distributions

The beneficiary should compare the broker-reported basis with the estate’s valuation records. A brokerage system may not automatically receive or correctly apply inherited-basis information.

Does community property receive a double step-up in basis?

Qualifying community property may receive a basis adjustment for both the deceased spouse’s share and the surviving spouse’s share.

This treatment generally applies when:

• The spouses owned the asset as community property, and

• At least one-half of the whole community-property interest is included in the deceased spouse’s gross estate.

State law, title, acquisition history, marital agreements, and tracing records determine whether an asset qualifies as community property. IRS Publication 551 provides additional guidance.

Do trust assets receive a step-up in basis?

Trust assets may receive a step-up when they are treated as property acquired from the decedent under Section 1014.

Step-Up in Basis for Revocable Living Trusts 

Property in a revocable living trust commonly qualifies because the decedent generally retained a power to revoke or amend the trust and the property is treated as acquired from the decedent under Section 1014.

Step-Up in Basis for Irrevocable Trusts 

Property in an irrevocable trust does not automatically receive a step-up when the grantor dies. The result depends on the trust terms, retained powers, ownership history, and whether the property is treated as acquired from the decedent under Section 1014.

Trust title alone does not determine the basis result.

What is the difference between step-up in basis and gift basis?

Inherited property and gifted property generally use different basis rules.

Gift Basis vs. Inherited Basis Example 

An individual paid $30,000 for stock that later became worth $120,000.

• If the individual gives the stock away during life, the recipient generally receives the $30,000 carryover basis for calculating gain.

• If the recipient inherits the stock at death, the stepped-up basis is generally $120,000 when that is the applicable inherited value.

IRS Publication 551 explains carryover basis and the dual-basis rules for gifts.

Does the One-Year Gift-Back Rule Prevent a Step-Up in Basis? 

It can. Under IRC Section 1014(e), the exception generally applies when:

1. Appreciated property was acquired by the decedent by gift within one year before death, and

2. The property passes from the decedent to the original donor or the donor’s spouse.

For this rule, property is appreciated when its fair market value on the gift date exceeds its adjusted basis.

When the exception applies, the recipient’s basis is generally the decedent’s adjusted basis immediately before death rather than an increased date-of-death basis.

How Does Form 8971 Affect Step-Up in Basis? 

When the consistent-basis requirements apply, a beneficiary generally cannot claim an initial basis greater than the estate-tax value reported for that property on Schedule A of Form 8971.

Before the value becomes final for federal estate-tax purposes, Schedule A generally reports the value shown on Form 706, Form 706-NA, or a supplemental estate-tax return. Supplemental reporting may be required if the reported information changes or the property’s final value is later determined.

Form 8971 is generally required for executors or other persons required to file Form 706 or Form 706-NA. It generally is not required when Form 706 is filed solely for portability, as a protective filing, or for certain generation-skipping transfer elections.

Form 8971 does not apply to every estate or every inherited asset. The Instructions for Form 8971 and Schedule A explain the filing exceptions, excluded property, reporting deadlines, and supplemental-reporting requirements.

What Records Are Needed to Support a Step-Up in Basis? 

Beneficiaries should retain records establishing the applicable inherited value and later basis adjustments:

• Will or trust documents

• Probate and distribution records

• Date-of-death appraisal

• Alternate valuation documentation

• Form 706 or Form 706-NA schedules

• Schedule A of Form 8971

• Brokerage valuation statements

• Real estate closing documents

• Capital-improvement invoices

• Land and building allocations

• Depreciation schedules

• Joint-ownership or community-property records

These records should generally be retained while the property is owned and for the applicable recordkeeping period after its sale or other disposition.

Step-Up in Basis FAQs 

Is an Appraisal Required for a Step-Up in Basis? 

An appraisal is not required in every estate, but reliable valuation evidence is necessary. A qualified retrospective appraisal is often the strongest support for inherited real estate, business interests, collectibles, and other assets without readily available market prices.

Does a Mortgage Reduce the Step-Up in Basis of Inherited Property? 

A mortgage generally does not reduce the property’s full fair-market-value starting basis. The debt affects the beneficiary’s equity and net sale proceeds. In a taxable disposition, debt relief can also affect the amount realized.

What Happens If You Sell Inherited Property Immediately? 

An arm’s-length sale near the valuation date may help establish fair market value. Gain or loss still depends on the documented stepped-up basis, selling expenses, and any adjustments occurring before the sale.

Can a Beneficiary Choose the Date-of-Death or Alternate Valuation? 

No. The executor must make a valid estate-wide alternate valuation election. A beneficiary cannot independently choose whichever value produces the better income-tax result.

What Happens If Inherited Property Is Sold Below Its Step-Up in Basis? 

A beneficiary may recognize a capital loss if the property was held for investment and the transaction otherwise qualifies. A loss from the sale of personal-use property is generally not deductible.