Step-Up in Cost Basis: A Tax Break for Heirs

One of the most valuable tax benefits available to families is the step-up in cost basis of assets owned by a decedent at death. For income tax purposes, it is often better to hold assets until death rather than selling or gifting them during life.

What It Means

  • Most assets receive a new tax cost basis equal to their fair market value at death.
  • This wipes out prior capital gains and resets the holding period as “long-term,” so heirs can often sell with little or no tax.
  • Example: Stock bought for $100,000 and worth $400,000 at death → heirs’ cost basis is $400,000. Selling for $410,000 means tax on just $10,000.

Assets That Don’t Get a Step-Up: Income in Respect of a Decedent (IRD)

  • Retirement accounts (IRAs, 401(k)s)
  • Unpaid income, interest, or bonuses
  • Installment sale payments

Real Estate & Business Assets

  • A step-up erases prior depreciation recapture.
  • Heirs start fresh with new depreciation deductions.
  • This is especially powerful for rental property and business equipment.

Partnerships & LLCs

  • Heirs receive a step-up in their ownership interest.
  • If the partnership makes a Section 754 election, the partnership’s underlying assets can also be stepped up, creating extra tax savings through new depreciation and reduced gain on future sales.

Key Takeaways

✔ In community property states, both halves of marital property usually get a step-up at the first spouse’s death.

✔ Determining fair market value at death is important to ensure heirs benefit from the step-up. Estates that exceed the federal exclusion amount may also have IRS cost basis reporting requirements.

✔ Gifting assets during life usually shifts your existing cost basis to heirs, while inherited assets typically get a step-up.

✔ Selling assets shortly before death may waste the step-up opportunity and trigger unnecessary income tax. You do not have to incur estate tax to benefit from the step-up!

✔ For assets held a long time, determining cost basis can be difficult. Passing these assets at death avoids the burden of reconstructing old records.

The Analysis

The step-up in basis can save families significant taxes, but not all assets qualify. Before selling or gifting property, consult with your professional advisors to see whether holding onto it is the smarter choice.

A complete tax analysis should consider your income tax brackets, any loss carryforwards, and overall estate planning goals. I have seen many families sell assets to simplify an aging parent’s affairs, only to face steep income taxes because cost basis records were missing. With good planning, this burden can often be avoided.

By Elyse W. Germack, Attorney & CPA

Not legal or tax advice. Not updated for change in tax laws. Consult your personal advisors before taking any action.

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