Step-up in basis — definition & guide

The adjustment of an asset's cost basis to its fair market value at the owner's date of death. Eliminates capital gains tax on all appreciation that occurred during the decedent's lifetime.

Under IRC Section 1014, most assets held at death receive a new basis equal to the FMV on the date of death. The heir then uses that stepped-up basis for any future sale, eliminating capital gains tax on appreciation during the decedent’s lifetime. Community property states give a full step-up on both spouses’ halves of community property at the first death, a double step-up that common law states do not provide. Retirement accounts (401(k), IRA) do not receive a step-up because they are already funded with pre-tax dollars.

Example: a founder holds 500,000 shares with a $0.01 basis. She dies when the stock trades at $140. Her spouse inherits the shares at a $140 basis. If the spouse sells immediately, no capital gain is recognized. If the couple lived in California (community property), the surviving spouse gets the double step-up on both halves.

Common mistake: gifting highly appreciated assets to elderly parents shortly before death, hoping to use the step-up. Section 1014(e) disallows the step-up if the asset is inherited back within one year of the gift.

The step-up matters at estate planning design, at large concentrated positions, and at evaluating hold-versus-sell decisions for older clients.