The step-up in basis is one of the most powerful and underappreciated features of the U.S. tax code. When someone dies, the assets in their estate get a new cost basis equal to the fair market value on the date of death. That reset can wipe out a lifetime of unrealized capital gains for the heirs, but only if the assets pass at death rather than as a lifetime gift.

What cost basis is

Cost basis is what you paid for an asset, and capital gains tax is charged on the difference between the sale price and that basis. If you buy stock for 20,000 dollars and sell it for 120,000 dollars, you have a 100,000-dollar taxable gain. Basis therefore determines how much tax you owe when you sell. The step-up changes that number dramatically at death.

How the step-up works

When an asset passes through someone's estate, its basis is reset to the fair market value on the date of death (or an alternate valuation date). An heir who inherits that 120,000-dollar stock takes a basis of 120,000 dollars, so if they sell it right away they owe essentially no capital gains tax. The decades of appreciation the original owner built up simply disappear for tax purposes. This applies to stocks, real estate, and other appreciated property held at death.

Gifts do not get the step-up

Assets given away during life carry over the giver's original basis, with no step-up. If a parent gifts that same stock while alive, the child inherits the 20,000-dollar basis and owes tax on the full 100,000-dollar gain when they sell. This is why gifting highly appreciated assets is often worse for heirs than letting them inherit at death. The choice between gifting now and bequeathing later has real tax consequences.

Community property and planning notes

In community property states, both halves of a married couple's community assets can receive a full step-up when the first spouse dies, a valuable advantage. The step-up applies to appreciation, but assets that lost value get a step-down instead, which can waste a loss. Retirement accounts like traditional IRAs and 401(k)s do not get a step-up, since their withdrawals are taxed as ordinary income. Coordinating which assets to hold, gift, or bequeath can save heirs substantial tax.

A father bought stock for 20,000 dollars that is worth 120,000 dollars at his death. His daughter inherits it with a stepped-up basis of 120,000 dollars and sells immediately, owing essentially no capital gains tax. Had he instead gifted the shares while alive, she would have kept his 20,000-dollar basis and owed tax on a 100,000-dollar gain.

Key takeaways

  • Inherited assets get a basis reset to fair market value at the date of death.
  • The step-up can erase decades of unrealized capital gains for the heirs.
  • Lifetime gifts carry over the giver's original basis and get no step-up.
  • Traditional retirement accounts do not receive a step-up, unlike taxable investments and real estate.

Common mistakes

FAQ

Does a 401(k) get a step-up in basis?

No. Traditional retirement accounts are taxed as ordinary income to heirs and do not receive a basis step-up.

Is it better to gift assets or leave them at death?

For highly appreciated assets, leaving them at death usually gives heirs a valuable step-up, while gifting keeps your low basis. The best choice depends on your full tax picture.