What is the step-up in basis and how does it work?

When you inherit an asset, the cost basis for capital gains purposes is reset (stepped up) to the fair market value (FMV) of the asset on the date the original owner died. This means if the original owner bought a stock for $10,000 and it was worth $100,000 at death, the heir inherits a basis of $100,000 — not $10,000. If the heir then sells the stock for $105,000, they only owe capital gains tax on the $5,000 gain above the stepped-up basis, not on the $90,000 increase that occurred during the original owner's lifetime.

Does the step-up in basis apply to assets in an IRA or 401(k)?

No. The step-up in basis does NOT apply to assets held in tax-deferred retirement accounts (traditional IRAs, 401(k)s, 403(b)s). When you inherit a traditional IRA or 401(k), withdrawals are taxed as ordinary income — there is no step-up. The step-up in basis applies only to assets that would otherwise be subject to capital gains tax: stocks, mutual funds, real estate, business interests, and other capital assets held in taxable accounts. Roth IRA assets have no unrealised gains to step up (qualified withdrawals are already tax-free).

What is a step-down in basis?

If an inherited asset is worth LESS at death than the original owner paid for it, the basis steps DOWN to the current FMV. This is called a step-down in basis. The heir inherits the lower value as their basis. If they then sell at a further loss, they can deduct the loss below the stepped-down basis. However, the unrealised loss that existed before death is permanently lost — the original owner could have sold to harvest the loss; once they die, that loss disappears.

How does the step-up work for community property vs separate property?

In community property states (California, Texas, Arizona, Nevada, Washington, Idaho, Louisiana, New Mexico, Wisconsin), both halves of community property assets receive a step-up at the death of either spouse — not just the deceased spouse's half. This means on a jointly-owned stock portfolio in a community property state, the entire portfolio steps up in basis when one spouse dies, not just the 50% owned by the deceased. In non-community property (common law) states, only the deceased spouse's half of jointly-held assets steps up.

Step-Up in Basis 2026 — How Inherited Assets Avoid Capital Gains Tax

The step-up in basis is one of the most powerful tax benefits in the US tax code for heirs. When you inherit capital assets — stocks, real estate, or a business — the cost basis resets to the fair market value on the date of death. This erases any unrealised capital gains that accumulated during the original owner’s lifetime. If the asset has appreciated significantly, the step-up can eliminate hundreds of thousands of dollars in capital gains tax for the heir.

Quick answer: Inherited assets get a new cost basis equal to the FMV at the date of death. If the original owner paid $20,000 for stock now worth $200,000, you inherit a $200,000 basis. Sell immediately: no capital gains. Sell later at $210,000: you owe tax only on the $10,000 gain above $200,000. Does NOT apply to IRAs, 401(k)s, or other tax-deferred retirement accounts.

How the Step-Up in Basis Works

Example 1: Inherited Stocks

Item	Amount
Original owner’s purchase price (original basis)	$15,000
Fair market value at date of death	$180,000
Heir’s stepped-up basis	$180,000
Unrealised gain erased by step-up	$165,000
If heir sells immediately (at $180,000): capital gain	$0
If heir sells 2 years later at $195,000: capital gain	$15,000
Long-term CGT at 15% rate on $15,000	$2,250

Without the step-up, the heir would owe taxes on the full $165,000 gain if they sold shortly after inheriting — up to $33,000 at the 20% rate.

Example 2: Inherited Real Estate

An investor purchased a rental property in 1990 for $80,000. At death in 2026, the property is worth $650,000.

Original cost basis (plus improvements, minus depreciation): $50,000
Stepped-up basis at death: $650,000
If heir sells immediately: $0 capital gains tax
Depreciation recapture also eliminated by the step-up

Holding Period: Automatically Long-Term

All inherited assets are treated as long-term capital gains property, regardless of how long the heir holds them. Even if you sell an inherited stock the day after you inherit it, any gain above the stepped-up basis is taxed at long-term capital gains rates (0%, 15%, or 20%) — not at short-term (ordinary income) rates.

This is another advantage over gifted assets, where the recipient inherits the donor’s original holding period.

Assets That Receive a Step-Up

The step-up applies to assets that are included in the deceased’s gross estate for federal estate tax purposes:

Asset Type	Step-Up Applies?
Stocks and ETFs (taxable accounts)	Yes
Mutual funds (taxable accounts)	Yes
Real estate (not principal residence with exclusion)	Yes
Business interests (partnerships, LLC interests)	Yes
Bonds (unrealised premium/discount)	Yes
Collectibles (art, coins, wine)	Yes
Traditional IRA / 401(k) / 403(b)	No — ordinary income on withdrawal
Roth IRA	No step-up needed — already tax-free
Annuities	No — gains taxed as ordinary income
US Savings Bonds (deferred interest)	No — interest taxed as ordinary income

Step-Up vs Step-Down

The basis adjustment goes both ways:

Step-up: Asset is worth more at death than original cost → basis steps up to FMV (common; beneficial)

Step-down: Asset is worth less at death than original cost → basis steps DOWN to FMV (loss is forfeited)

Planning implication: If an elderly parent holds an asset at a loss, they should consider selling it before death to harvest the capital loss. After death, the step-down means the heir inherits a higher basis than current value — but the loss the parent held cannot be claimed by anyone.

Community Property: A Double Step-Up

In the nine community property states (CA, TX, AZ, NV, WA, ID, LA, NM, WI), married couples can own property as community property. When one spouse dies:

Community property: The ENTIRE asset — both halves — receives a step-up to current FMV
Joint tenancy (non-community property): Only the deceased spouse’s 50% half steps up; the surviving spouse’s 50% retains its original basis

Example in California: A married couple bought stock for $60,000. At the death of one spouse, the stock is worth $400,000. Held as community property: the surviving spouse’s entire $400,000 holding steps up. Held as joint tenancy: only $200,000 (half) steps up. The surviving spouse’s half retains a $30,000 basis.

This makes community property designation extremely valuable in high-basis-step-up situations.

IRAs and 401(k)s: No Step-Up

This is the most common misunderstanding. Tax-deferred retirement accounts do not benefit from the step-up in basis.

When you inherit a traditional IRA or 401(k), you must pay ordinary income tax on every dollar withdrawn — just as the original owner would have. The step-up rule does not apply because the original contributions were pre-tax (never taxed). The IRS will eventually collect that tax, regardless of who owns the account.

Planning implication: Consider holding appreciated investments in taxable brokerage accounts (where step-up applies) and less appreciated or more ordinary-income-generating assets inside IRAs. Over a lifetime, this “asset location” strategy can reduce the total tax burden for your heirs.

Gifted vs Inherited Assets: Basis Comparison

Scenario	Basis Received
Inherited asset	FMV at date of death (step-up)
Gifted asset (while donor alive)	Donor’s original basis (carryover basis) — no step-up
Gifted asset sold at a loss	The lower of donor’s basis or FMV at date of gift

This means giving appreciated assets as gifts before death does not give the recipient a step-up — they inherit the original (lower) basis. Wealthy families often hold appreciated assets to death specifically to give heirs the step-up rather than gifting while alive.

Capital Gains Tax Rates 2026 — LTCG rates at 0%, 15%, 20%
Inherited Roth IRA Rules — 10-year rule and tax-free withdrawals
Estate Tax Exemption 2026 — federal estate tax threshold and rates
Capital Gains on Home Sale — Section 121 exclusion for primary residences
Capital Gains Tax Hub — all capital gains guides

The step-up in basis is one of the clearest arguments for holding appreciated assets — stocks, real estate, business interests — to death rather than gifting them while alive. For families with concentrated positions in appreciated stocks or real estate, strategic planning around the step-up can save heirs hundreds of thousands of dollars in capital gains tax.

Written by WealthVieu

WealthVieu researches and writes data-driven personal finance guides using primary sources including the IRS, Bureau of Labor Statistics, Federal Reserve, and Census Bureau.

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