When you inherit a house, a stock portfolio, or a rental building, your tax basis usually is not what the original owner paid. It resets to the value on the date of death. That single rule, IRC Section 1014, erases decades of unrealized gain and decides how much capital gains tax you owe when you sell.
What Is the Step-Up in Basis for Inherited Property?
The step-up in basis means your cost basis in inherited property equals its fair market value on the date the owner died. If your mother bought stock for $40,000 and it was worth $400,000 when she died, your basis is $400,000. The $360,000 of lifetime appreciation is never subject to income tax.
Basis is the number you subtract from the sale price to measure gain or loss. Without Section 1014, heirs would inherit the original owner's basis and owe tax on the full lifetime gain. With it, you owe tax only on growth after the date of death.
Step-Up Example: Inherited Stock
CalculationGain on sale = sale price minus stepped-up basis (date-of-death value).
- Original owner's purchase price: $40,000
- Fair market value on the date of death: $400,000 (your new basis)
- You sell eight months later for $410,000
- Taxable gain: $410,000 minus $400,000 = $10,000, taxed at long-term capital gains rates
- Without the step-up, the taxable gain would have been $370,000
The rule works in both directions. If the asset was worth less than the owner paid, basis steps down to the lower date-of-death value, and the owner's unrealized loss disappears for good. That is why selling loss positions before death, rather than holding them, is often the better plan for an aging investor.
How Is Fair Market Value Determined on the Date of Death?
Fair market value is the price a willing buyer would pay a willing seller on the date of death, with neither under pressure to act. For publicly traded stock, the value is generally the average of the highest and lowest trading prices on that date under the estate tax valuation regulations. If the death falls on a weekend or holiday, the value is a weighted average of the high and low prices on the nearest trading days before and after. For real estate, closely held businesses, and collectibles, you need a qualified appraisal dated as of the date of death.
Get the appraisal early, even if no estate tax return is due. A retrospective appraisal done years later is harder to defend in an audit, and the burden of proving basis is on you. Brokerage firms usually provide a date-of-death valuation report on request when they retitle the account.
What Is the Alternate Valuation Date?
The executor can elect to value all estate assets six months after death instead of on the date of death under IRC Section 2032. The election is made on Form 706, and it is allowed only if it reduces both the value of the gross estate and the estate tax owed. Most estates fall below the $15,000,000 federal exemption and owe no estate tax, so the alternate valuation date is rarely available to them.
When the election is made, heirs take the six-month value as their basis. Assets sold or distributed within that six-month window are valued on the date of the sale or distribution instead.
Which Assets Get a Step-Up in Basis?
Most capital and personal-use assets that are included in the decedent's gross estate step up. The test is inclusion in the estate for estate tax purposes, not whether any estate tax was actually owed.
| Asset | Step-up? | Why |
|---|---|---|
| Stocks, ETFs, mutual funds in a taxable account | Yes | Included in the gross estate under Section 2033 |
| Primary residence, vacation home, land | Yes | Included in the gross estate |
| Rental real estate | Yes | Basis resets, and prior depreciation recapture is eliminated |
| Revocable living trust assets | Yes | Treated as owned by the decedent at death |
| Cryptocurrency held directly | Yes | Treated as property, valued at death |
| Traditional IRA, 401(k), 403(b) | No | Income in respect of a decedent under Section 691 |
| Deferred annuity gain | No | Built-in gain is income in respect of a decedent |
| Unpaid wages, unreported gain on installment notes | No | Income in respect of a decedent |
| Assets gifted during life | No | Carryover basis under Section 1015 |
| Irrevocable grantor trust assets outside the estate | No | Rev. Rul. 2023-2 denies the step-up |
The retirement account exclusion catches many families off guard. A $500,000 traditional IRA and a $500,000 brokerage account look equal on a statement, but the heir of the brokerage account can sell tax-free while the IRA heir pays ordinary income tax on every pre-tax dollar withdrawn. Distribution timing for inherited IRAs is covered in our inherited IRA 10-year rule guide.
The One-Year Gift-Back Rule
CautionSection 1014(e) blocks a common workaround. If you give appreciated property to someone who dies within one year, and the property passes back to you or your spouse, you take back the decedent's adjusted basis immediately before death, which is generally your own original basis, and the step-up is lost. Deathbed gifts to a parent in the hope of getting the asset back with a fresh basis do not work.
How Does the Step-Up Work for Married Couples?
For a married couple, the step-up at the first death depends on how the property was titled and on state law. The difference can be worth tens of thousands of dollars on a single home.
In common law states, property held by spouses as joint tenants with right of survivorship is a qualified joint interest under Section 2040(b). Only the deceased spouse's half is included in the estate, so only that half steps up. The surviving spouse keeps the original basis on their own half.
In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), Section 1014(b)(6) steps up both halves of community property at the first death. A couple who bought a California home for $300,000 that is worth $1,500,000 at the first death leaves the survivor with a $1,500,000 basis on the entire house.
A surviving spouse who sells the home may still use the Section 121 exclusion. A survivor who has not remarried can claim the full $500,000 married exclusion if the sale occurs no later than two years after the spouse's death and the joint ownership and use requirements were met right before the death. See the home sale tax exclusion guide for the ownership and use tests.
Do You Pay Capital Gains Tax When You Sell an Inherited House?
You pay capital gains tax only on the gain above your stepped-up basis. Your basis is the date-of-death value plus any improvements you made after inheriting. Selling costs such as commissions and title fees reduce the amount realized, which often means a quick sale produces little or no taxable gain.
Inherited property is automatically treated as held for more than one year under Section 1223(9). Even if you sell a month after the death, the gain is long-term and is generally taxed at the 0 percent, 15 percent, or 20 percent rates, plus the 3.8 percent Net Investment Income Tax if your income is high enough. Inherited collectibles such as art and coins are taxed at up to 28 percent, and depreciation you claim after inheriting a rental is taxed at up to 25 percent when you sell. Current brackets are in our 2026 capital gains tax rates guide.
Heirs usually cannot use the Section 121 home sale exclusion on an inherited house. The exclusion requires that you personally owned and lived in the home for two of the five years before the sale, and the decedent's years of ownership do not count for a child or other non-spouse heir.
Selling an Inherited House at a Loss
ReferenceIf the house sells for less than its date-of-death value, the result depends on how you used it. If you listed it for sale promptly and never used it personally, the loss is generally a deductible capital loss, limited to $3,000 a year against ordinary income with the rest carried forward. If you rented it out, the house is Section 1231 property, the sale is reported on Form 4797, and a net Section 1231 loss is deductible as an ordinary loss. If you moved in or used it personally, the loss is a nondeductible personal loss.
How Does the Step-Up Apply to Inherited Rental Property?
Inherited rental property gets a new basis equal to its date-of-death value, and depreciation starts over. The heir allocates the new basis between land and building and begins a fresh 27.5-year schedule for residential rental property (39 years for commercial property). The land portion is never depreciable.
The step-up also wipes out the decedent's accumulated depreciation. Had the owner sold during life, prior depreciation would have been taxed as unrecaptured Section 1250 gain at up to 25 percent. After death, that recapture exposure is gone, which makes holding depreciated rental property until death one of the strongest tax outcomes in real estate. Owners weighing a sale versus a hold should compare this against a 1031 like-kind exchange, which defers gain and still allows a step-up at death.
For an inherited interest in a partnership or LLC taxed as a partnership, only your outside basis in the interest steps up automatically. A matching step-up in your share of the partnership's inside basis happens only if the partnership has a Section 754 election in effect, which triggers a Section 743(b) adjustment. Without the election, the only mandatory adjustment applies when the partnership has a substantial built-in loss of more than $250,000, measured at the partnership level or on your share, and that adjustment reduces basis. S corporations have no equivalent, so the entity's assets keep their old basis.
Why Does the $15 Million Estate Tax Exemption Make Step-Up Planning More Important?
The One Big Beautiful Bill Act set the federal estate and gift tax exemption at $15,000,000 per person ($30,000,000 for a married couple using portability) starting in 2026. With that exemption, most families will never pay federal estate tax. For them, the step-up is the main tax benefit left at death, and planning shifts from avoiding estate tax to preserving basis.
That changes several long-standing habits. Lifetime gifts of highly appreciated assets now often cost more than they save, because the recipient takes the donor's low carryover basis under Section 1015 and gives up the step-up. The trade-offs are discussed in our estate tax planning guide for the $15 million exemption and the gift tax annual exclusion guide.
The portability election matters here too. Filing Form 706 at the first spouse's death, even when no tax is due, preserves the deceased spouse's unused exemption. That lets more assets stay in the survivor's estate and receive a second step-up at the survivor's death without triggering estate tax.
What Is Consistent Basis Reporting and Form 8971?
When an estate is required to file Form 706, the executor must also file Form 8971 and give each beneficiary a Schedule A reporting the estate tax value of the property they receive. Under IRC Sections 1014(f) and 6035, if including the property in the estate increased the estate tax, your basis cannot exceed the value finally determined for estate tax purposes. Claiming a higher basis on your own return can trigger a 20 percent accuracy-related penalty.
If no Form 706 was required, no Schedule A is issued. In that case your own date-of-death appraisal or brokerage valuation is the record that supports your basis. Keep it with your permanent tax records, not only with the return for the year of sale.
How Do You Report the Sale of Inherited Property?
Report the sale on Form 8949 and Schedule D of Form 1040. Enter "INHERITED" in the date acquired column instead of a date, which tells the IRS the gain is long-term. Enter your stepped-up basis in the cost column.
Brokers often report the wrong basis on Form 1099-B for inherited shares, especially when the account was retitled without a date-of-death valuation. If the 1099-B basis is missing or wrong, report the correct basis on Form 8949 and use the adjustment column with the code the instructions require. For inherited real estate, the closing agent issues Form 1099-S showing gross proceeds only, so you must supply the basis yourself. If you rented the inherited property before selling it, report the sale on Form 4797 instead of Form 8949.
Have questions about inherited property or a sale you are planning? Contact TS CPA for help establishing basis and reporting the sale correctly. We respond the same day.