The stepped-up basis is a valuable tax provision that applies to assets inherited at someone’s death. The IRS resets the asset’s original cost basis to its value at the decedent’s date of death. If the asset is later sold, the heir pays capital gains tax on any appreciation above the stepped-up basis. So, inherited assets, if sold immediately after inheritance, generally have little or no capital gains. 

Assets Eligible for a Step-Up in Basis

• Stocks, bonds, mutual funds
• Real estate, including personal residences
• Collectibles
• Personal property 
• Businesses 

The tax outcome between someone transferring assets during their life and at death can be dramatically different. For assets gifted during someone’s lifetime, the donee (gift recipient) inherits the donor’s basis, a concept known as carryover basis. By contrast, for many families, a stepped-up basis helps reduce or avoid capital gains tax on assets passed down through multiple generations.

How a Step-Up in Basis Can Benefit Heirs

John, age 90, owns a 500-acre family farm that he now wants to gift to his son, John, Jr. Inherited from his mother when she died in 1972, the farm was valued at $200 per acre or a total of $100,000, so the tax basis is $100,000. The area around the property has developed, and the farm is now worth $5,000 per acre, or $2.5 million in total. If John gifts the property now, his son inherits John’s basis of $100,000. But if John passes to John, Jr. at his death, the basis is $2.5 million or the current market value. In this example, even if there is no plan to sell the farm, the increased basis may provide future tax advantages.

Step-Up Basis and Depreciation

Let’s say John owns an apartment building instead of a farm. He paid $100,000 and has owned it for 40 years. It’s now fully depreciated and worth $1.5 million. If he passes to John, Jr. at his death, the basis is reset to $1.5 million, and John, Jr. can now begin depreciating it using the new value. 

Spouses of decedents also receive a stepped-up basis on assets passed to them at death. 

When a Step-Up May Not Be Favorable

Let’s say you purchased a tract of land and for some reason it has declined in value. At your death, it’s reset to a value lower than your cost basis. In that situation, it may be advisable to sell and take the capital loss or offset capital gains. 

There may be instances where it’s preferable to make lifetime gifts of assets, but your estate planning and assets must be considered as a whole before gifting. 

Determining Fair Market Value

With stocks or bonds traded on an established market, it’s relatively easy to determine the fair market value on any given day. Other harder-to-value assets may require an appraisal to establish the stepped-up basis.

Evaluating the Impact on Your Estate Plan

Whether you're considering lifetime gifts, planning for business succession or evaluating appreciated assets, understanding how stepped-up basis rules apply can have significant tax implications. Contact our tax pros to discuss how these rules may affect your estate and tax planning strategy.