Step-Up in Basis at Death (IRC §1014): Tax Planning Guide for CPAs
Under IRC §1014(a), a beneficiary who inherits a capital asset takes a new cost basis equal to the asset's fair market value on the decedent's date of death — erasing all unrealized gain that accumulated during the decedent's lifetime. A client who bought stock for $80,000 that is worth $800,000 at death passes that asset to heirs with an $800,000 basis. The $720,000 of unrealized gain permanently disappears — no income tax is owed by the estate, the beneficiary, or anyone else on that appreciation. For clients with large unrealized gains in taxable brokerage accounts, rental property, or closely held business interests, §1014 is one of the most powerful tax outcomes in the Code, and understanding when it applies — and when it does not — is essential for any CPA doing estate and succession planning.
How the Step-Up Calculation Works
The stepped-up basis is the fair market value of the property on the decedent's date of death. For publicly traded securities, FMV is the average of the high and low trading prices on the date of death (IRS Publication 551). For real estate, a qualified appraisal dated within the valuation window is required. For closely held business interests — S-Corp stock, LLC membership interests, partnership interests — a valuation by a credentialed professional (CVA or ABV) is standard.
Alternate valuation date. Under IRC §2032, an executor can elect to value estate assets at the date six months after death. This election is only available if: (1) the estate owes federal estate tax, and (2) both the gross estate value and the estate tax liability are lower on the alternate date than on the date of death. If elected, the basis for all inherited assets reflects the alternate-date FMV. It cannot be used as a standalone income tax reduction tool when no estate tax is owed.
Holding period reset. Under IRC §1223(9), an heir who inherits a capital asset is automatically treated as having held it long-term, regardless of how long the decedent held it or how quickly the heir sells. An heir who inherits stock on March 1 and sells on March 15 pays long-term capital gains rates — not short-term.
Which Assets Get the Step-Up — and Which Do Not
The step-up applies to property included in the decedent's gross estate under IRC §§2033–2046. This covers:
- Individually owned capital assets: real estate, securities, collectibles, closely held business interests
- Jointly owned property, to the extent includible in the gross estate
- Assets in a revocable living trust (fully included under IRC §2038)
- Community property in community property states (see below)
Assets that do NOT receive a step-up:
Income in Respect of a Decedent (IRD). Under IRC §691, income earned or accrued before death but not yet received carries no basis step-up. The beneficiary receives the IRD and pays ordinary income tax on it in full. Common IRD items include:
- Traditional IRA and 401(k) balances — distributions are fully taxable as ordinary income to the beneficiary
- SEP-IRA and SIMPLE IRA balances
- Deferred compensation not yet received at death
- Installment sale receivables (the unrecognized gain portion)
- Accrued wages, vacation pay, and accounts receivable for a cash-basis taxpayer
An IRD deduction is available under IRC §691(c): beneficiaries may deduct the federal estate tax attributable to the IRD item. But it does not eliminate income tax — it only provides a partial offset proportional to the estate tax paid on that item.
Lifetime gifts. Assets gifted before death carry the donor's carryover basis to the recipient under IRC §1015 — there is no step-up. This rule is the entire basis for the hold-until-death planning strategy. For the full comparison of basis rules, gift tax reporting requirements, and annual exclusion strategies, see Inheritance vs. Gift: Tax Implications CPAs Must Know.
Property transferred to irrevocable trusts before death. Assets removed from the taxable estate through a completed irrevocable transfer are not included in the gross estate under §2033, so they receive no §1014 step-up.
Community Property States: The Double Step-Up
In the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), each spouse owns 50% of marital property by operation of law. Under IRC §1014(b)(6), when one spouse dies, both halves of community property receive a step-up to FMV — not just the deceased spouse's share.
The planning impact is material. Consider a California couple who purchased stock for $200,000 as community property, now worth $1,000,000 at the first spouse's death:
| Common Law State (e.g., New York) | Community Property State (e.g., California) |
|---|---|
| Only decedent's 50% steps up to $500,000 | Both halves step up to $1,000,000 total |
| Surviving spouse holds with ~$600,000 blended basis | Surviving spouse holds with $1,000,000 basis |
| Capital gain if sold immediately: ~$400,000 | Capital gain if sold immediately: $0 |
Clients in community property states who hold appreciated assets as separate property can often retitle to community property before death to capture the full double step-up — but the transfer must be completed with valid written consent before death, not merely intended. California, Nevada, and Washington provide community property agreements for this purpose.
Four Planning Strategies Built Around §1014
1. Hold appreciated assets — never gift them while alive. Gifting an appreciated asset to a child or heir transfers the donor's carryover basis. Dying with the same asset gives the heir a stepped-up basis. For clients with substantial unrealized gains, the step-up is almost always the superior path. The exception: gifts to donees in the 0% long-term capital gains bracket who will sell immediately can capture a current tax benefit. For 2025 bracket thresholds, see Short-Term vs Long-Term Capital Gains Tax Rates 2025.
2. Gift assets with losses, hold assets with gains. Assets that have declined in value should be sold before death to recognize the capital loss — dying with a loss asset causes a step-down in basis to FMV, permanently eliminating the deductible loss. A client holding stock that fell from $100,000 to $40,000 should sell and harvest the $60,000 loss; an heir who inherits instead receives only a $40,000 basis with no loss deduction available.
3. The buy-hold-exchange-die strategy for real estate. For real estate investors, §1014 combines powerfully with §1031 exchanges to permanently eliminate a lifetime of accumulated capital gains. The strategy: acquire appreciating investment property, use 1031 like-kind exchanges to defer gain recognition at each sale, and hold the final property until death. The heir takes a stepped-up basis equal to FMV, and all deferred §1231 gain and §1250 depreciation recapture built up across decades of exchanges disappears permanently. For clients starting this strategy early enough, the cumulative tax elimination can be extraordinary.
4. Weigh the step-up against estate tax exposure. The step-up eliminates income tax on unrealized gains, but the same appreciation that creates the income tax benefit also increases the taxable estate, potentially triggering estate tax at the 40% federal rate on amounts above the exemption. OBBBA raised the federal estate and gift tax exemption to $15 million per individual ($30 million for a married couple using portability) — confirm the exact effective date in the enacted statutory text. For clients below the exemption, the step-up is a pure win. For clients above it, holding appreciated assets maximizes income tax savings but also increases estate tax exposure — the central tradeoff in high-net-worth estate planning. For a full CPA strategy guide on exemption mechanics, portability, gifting techniques, and state tax exposure, see Estate and Gift Tax Planning Under the OBBBA $15M Exemption. For the full succession planning framework, see Business Succession Planning: Tax and Insurance Components.
§1014 and Closely Held Business Interests
The step-up applies to S-Corp stock, LLC membership interests, and partnership interests, but the mechanics differ by entity type.
S-Corp: The heir's stock basis steps up to FMV, but the S-Corp's inside basis — the adjusted basis of assets held within the corporation — does not automatically adjust. If the S-Corp holds assets with significant embedded gain, that gain will still pass through to the heir when the S-Corp eventually sells those assets. There is no S-Corp equivalent of the partnership §754 election to align inside and outside basis.
Partnerships and multi-member LLCs: A partnership can make an IRC §754 election that causes a §743(b) adjustment — stepping up the inside basis of partnership assets to reflect the heir's stepped-up outside basis. Without the election, the heir's stepped-up outside basis provides no protection against inside gain. CPAs should confirm whether an entity has a §754 election in place immediately after any death event involving a partnership interest.
Buy-sell agreements: A cross-purchase buy-sell agreement preserves the step-up benefit for surviving purchasers — each buyer takes a new basis equal to the purchase price (FMV) in the acquired interest. An entity redemption structure does not increase surviving owners' basis in their original interests. The complete basis analysis for each structure is in How to Structure a Buy-Sell Agreement.
CPA Checklist: Reporting Inherited Property
When a client inherits an asset:
- Establish FMV at date of death — broker statement for securities, qualified appraisal for real estate and business interests
- Confirm estate inclusion — verify the asset was in the gross estate; irrevocably transferred assets and prior gifts may not qualify
- Check for alternate valuation date — if an estate tax return was filed, confirm whether the §2032 election was made
- Confirm community property status — in CP states, separate vs. community classification controls whether one or both halves step up
- Segregate IRD items — retirement accounts, deferred compensation, and installment receivables use carryover basis and are not eligible for the step-up
- Verify §754 election for partnership interests — contact the partnership; an election made now protects the heir from inside gain on future asset sales
- Document long-term holding period — note IRC §1223(9) in the file; the heir qualifies for long-term rates on any subsequent sale regardless of holding duration
Frequently Asked Questions
What assets receive a step-up in basis at death?
Under IRC §1014(a), any property included in the decedent's gross estate receives a stepped-up basis equal to FMV at date of death. This includes individually owned real estate, securities, closely held business interests, collectibles, and assets held in a revocable living trust. Assets removed from the estate through irrevocable trusts, completed lifetime gifts, and Income in Respect of a Decedent (IRD) items — including IRAs and qualified plan balances — do not receive the step-up.
Does the step-up in basis apply to IRA and 401(k) accounts?
No. Retirement accounts are IRD under IRC §691. Distributions from an inherited traditional IRA or 401(k) are fully taxable as ordinary income to the beneficiary. The beneficiary may claim a partial deduction for estate tax attributable to the IRD under §691(c), but there is no basis to step up — the decedent never paid income tax on the contributions or growth. Roth IRA balances are also excluded from the §1014 step-up, though qualified Roth distributions are tax-free to beneficiaries for a different reason.
Do both spouses get a step-up in community property states?
Yes. Under IRC §1014(b)(6), both halves of community property step up to FMV at the first spouse's death. This means a surviving spouse in California, Texas, Nevada, or another community property state receives a fully stepped-up basis on the entire community property portfolio after the first death, not just the deceased spouse's half. In common law states, only the deceased spouse's share included in the gross estate receives the step-up — the surviving spouse's half retains its original basis.
What happens to depreciation recapture when rental property is inherited?
The §1014 step-up resets the heir's basis to FMV at date of death, permanently eliminating all accumulated §1250 depreciation recapture from the decedent's ownership. If the heir sells the inherited property immediately, there is no recapture and no capital gain — the entire difference between FMV and the heir's stepped-up basis is zero. This is why real estate investors combine 1031 exchanges with a hold-until-death strategy: decades of deferred recapture disappear in the estate. For the full recapture mechanics and planning analysis, see Depreciation Recapture on Rental Property.
What happens if a client gifts appreciated property instead of holding until death?
The donee receives the donor's carryover basis under IRC §1015 — there is no step-up. If the client gifts stock worth $500,000 with a $50,000 basis, the recipient holds a $50,000 basis and owes capital gains tax on the full $450,000 of unrealized appreciation when they sell. Dying with the same stock would have produced a $500,000 stepped-up basis with no tax owed. Reversing a completed gift requires the donee to give the property back to the donor — possible but requires care around gift tax return positions already filed.
Does a revocable living trust affect the step-up in basis?
No. Assets in a revocable trust are fully included in the grantor's gross estate under IRC §2038, because the grantor retains the power to revoke the trust and reclaim the assets. Since they remain in the estate, they receive the full §1014 step-up at death. Revocable trusts avoid probate administration and maintain privacy, but they do not change estate tax exposure or the income tax basis treatment of trust assets.
Is the step-up in basis at risk of being repealed?
The step-up under §1014 was preserved by OBBBA 2025 and is current law as of 2026. Prior legislative proposals — including the Biden administration's proposal to impose a deemed realization event at death — were not enacted. CPAs should monitor ongoing congressional activity around estate and capital gains tax reform, but the rule is intact and reliable for current planning purposes.
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