Death and taxes are usually the only two certainties in life, but honestly, the step up in basis at death is the one rare moment where the tax man actually blinks. It sounds like dense legalese. It’s not. It is probably the single most powerful wealth-transfer tool in the entire U.S. tax code, and yet most people don't realize they've stumbled into it until a lawyer mentions it during a mourning period.
Think about your parents' house. Maybe they bought it in 1978 for $40,000. Today, that suburban split-level is worth $650,000. If they sold it tomorrow, they'd be staring down a massive capital gains tax bill, even with the primary residence exclusion. But if you inherit that house after they pass away? The IRS acts like the "cost" of the house was $650,000 the day you got the keys. That’s the "step up." The $610,000 of profit basically vanishes into thin air as far as the government is concerned.
It’s a massive loophole. Some call it a "trust fund loophole," but it applies to anyone inheriting a piece of property, a brokerage account, or even a vintage car collection.
Why the IRS resets the clock
To understand why this matters, you have to understand "basis." In the eyes of the Treasury Department, basis is what you paid for something. If you buy a share of Apple for $150, your basis is $150. If you sell it for $200, you owe taxes on that $50 gain. Simple.
But when someone dies, the tax code shifts gears. Section 1014 of the Internal Revenue Code is the engine here. It dictates that the basis of property acquired from a decedent is generally the fair market value (FMV) at the date of the decedent's death.
Why? Because trying to figure out what Grandpa paid for a plot of land in 1954 is a nightmare. Documentation gets lost. Records disappear. The government, in a rare moment of pragmatism, decided it’s easier to just reset the value to "today's price" rather than making heirs hunt through dusty filing cabinets for a receipt from the Eisenhower administration.
Of course, this creates a massive incentive to hold onto appreciated assets until the very end. If you give that Apple stock to your daughter while you're alive, she keeps your $150 basis. That’s a "carryover basis." If she sells it, she’s paying your taxes. If she inherits it? Her basis is the market price on the day you passed. She could sell it the next afternoon and owe $0 in capital gains.
The mechanics of the valuation
It isn't always as simple as checking the stock ticker. For real estate, you usually need a formal appraisal. You can't just guess. The IRS wants to see a professional opinion of value as of the date of death.
Sometimes, executors use what’s called the Alternate Valuation Date. This is a niche move. Under Section 2032, if the total value of the estate drops in the six months following the death, the executor can choose to value the assets six months out instead of on the date of death. This is mostly used to lower estate tax hits for the ultra-wealthy, but for most of us, the date of death is the gold standard.
Community Property vs. Common Law States
This is where it gets kinda weird. Where you live changes everything.
In "Common Law" states (most of the US), if a couple owns a house jointly and one spouse dies, only the deceased spouse's half gets a step up. If you bought a house for $200k and it’s now worth $1M, the surviving spouse's basis becomes $600k (their original $100k half plus the stepped-up $500k half).
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But in Community Property states—think California, Texas, Arizona, Washington—you get a "double step up." When one spouse dies, the entire property gets stepped up to the current market value. The surviving spouse could sell the whole thing immediately and pay nothing in tax. It’s a massive advantage for residents of those states, and it’s why some people move their assets into "Community Property Trusts" even if they live in places like Tennessee or South Dakota.
Assets that don't get the boost
Don't get too excited about your 401(k) or IRA.
The step up in basis at death has a major enemy: Income in Respect of a Decedent (IRD). This is money that was never taxed while the person was alive because it was in a tax-deferred account. IRAs, 401(k)s, and 403(b)s do not get a step up. When you inherit an IRA, you're inheriting a future tax bill. You will eventually have to pay ordinary income tax on every dollar you take out of that account.
Same goes for annuities and unpaid wages. If the asset represents "earned income" that hasn't been taxed yet, the IRS isn't going to let it slide just because someone passed away.
- Real Estate: Yes.
- Stocks/Bonds: Yes.
- Crypto: Yes (and this is huge for early Bitcoin adopters).
- Artwork: Yes.
- Traditional IRA: No.
- Roth IRA: Sorta (The assets don't "step up," but the withdrawals are tax-free anyway if rules are met).
The "Step Down" in Basis
Nobody talks about this. It’s the depressing cousin of the step up. If you own an asset that has lost value—say you bought a tech stock at the peak of the bubble and it’s crashed—and you hold it until you die, the basis "steps down."
Your heirs lose the ability to use that capital loss to offset their own gains. From a cold, hard tax perspective, it’s actually better to sell losing assets while you're alive to harvest the tax loss, and keep the winning assets until you pass away so your heirs get the step up.
Real world impact: The family farm example
Let’s look at a classic case. The Miller family has a farm in Iowa. It’s been in the family since 1940. The original cost basis is basically $0. The land is now worth $5 million.
If the parents sell the farm to retire, they owe 20% in federal capital gains, plus likely a 3.8% Net Investment Income Tax (NIIT), plus state taxes. They could easily lose $1.5 million to the government.
If they wait and pass it to their kids through their will, the kids get a $5 million basis. The kids can then sell the farm, take the full $5 million, and start their own businesses or buy different land. The step up in basis at death effectively preserves $1.5 million of family wealth that would have otherwise gone to Washington.
The political crosshairs
Politicians love to talk about getting rid of this. You'll hear it called the "Angel of Death loophole."
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During the 2021-2022 legislative sessions, there was a heavy push to eliminate the step up or treat death as a "realization event" (meaning you pay taxes when you die, regardless of whether you sell). So far, these efforts have failed. Why? Because it’s incredibly unpopular with middle-class families who have seen their home values explode. It’s also a logistical nightmare for the reasons mentioned earlier—proving basis on old assets is nearly impossible for the average person.
However, the "Sunset" of the Tax Cuts and Jobs Act (TCJA) in 2026 is looming. While the step up itself isn't directly on the chopping block in that specific sunset, the estate tax exemptions are scheduled to drop by about half. This makes the step up even more important for families trying to navigate a shifting tax landscape.
Is it a "Gift" or a "Bequest"?
Don't confuse the two.
I see this all the time. A parent wants to "simplify things" and adds their child's name to the deed of their house while they are still alive.
This is usually a massive mistake.
When you add your child to the deed, you are making a gift. They take your original basis. If you bought the house for $50k and it’s worth $500k, and you put them on the deed, their basis is $25k (half of yours). When you die, they only get a step up on your remaining half. By trying to be "helpful" and avoid probate, you just cost your kid tens of thousands of dollars in future taxes.
Inheriting is almost always better than being "gifted" highly appreciated property.
Strategies for the savvy
So, what do you actually do with this information?
First, inventory your assets. If you have stocks with massive gains, those are the "hold until death" assets. If you need cash, it’s often better to sell the assets with the smallest gains first.
Second, look at your primary residence. If you’re a widow or widower, you have a two-year window after your spouse's death to sell the house and still claim the full $500,000 capital gains exclusion. After that, it drops back to $250,000. But if you keep the house until you pass, your kids get the full step up.
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Third, get an appraisal immediately when someone dies. I can't stress this enough. Even if you don't plan on selling the house for ten years, you need a documented value of what it was worth on the day they died. If you wait five years to get an appraisal, the IRS might challenge your "back-dated" estimate. An appraisal usually costs $500 to $700. It can save $50,000 in taxes later.
Nuance: The Portability Factor
For very large estates, we have to talk about portability. This is the ability of a surviving spouse to "inherit" the unused estate tax exemption of the deceased spouse. While this is more about the Estate Tax (the tax on the right to transfer property) than the Step Up (the tax on the gain), they work in tandem.
If you use a "Bypass Trust" (sometimes called a Credit Shelter Trust) to save on estate taxes, you might actually lose the step up on the assets inside that trust when the second spouse dies. This is because the assets in the Bypass Trust aren't technically in the second spouse's estate.
In the old days (when the estate tax exemption was only $600,000), everyone used Bypass Trusts. Now that the exemption is over $13 million (at least until 2026), many families are actually "undoing" these trusts so they can get the step up in basis at death instead. It’s a complete 180-degree turn in estate planning strategy.
What about the 1031 Exchange?
If you're a real estate investor, you know about the 1031 exchange—it lets you swap one investment property for another and kick the tax can down the road.
The ultimate "pro move" in real estate is the "Swap 'til you drop." You buy a rental property, it gains value, you 1031 exchange it for a bigger one, you keep doing that for 40 years, and then you die. All those deferred taxes? They vanish. Your heirs get the building at a stepped-up basis, and the decades of deferred capital gains are never paid.
It’s completely legal. It’s also one of the reasons real estate remains the preferred wealth-building tool for the American elite.
The emotional side of the tax code
It feels clinical to talk about basis and market values when someone has just lost a parent or a spouse. But the step up in basis at death is essentially a parting gift from the tax code. It’s a recognition that during a time of transition, the last thing a family needs is to be forced to sell a family home or a business just to pay a tax bill on "paper gains" that accumulated over decades.
Actionable Next Steps
- Document Everything: If you've recently inherited an asset, find the fair market value for the date of death now. Don't wait. Print out stock prices, get a formal real estate appraisal, and save them in a permanent file.
- Review Your Deed: If you added a child to your home's deed to "avoid probate," talk to an estate attorney about a Transfer on Death (TOD) deed or a Living Trust instead. These tools avoid probate without killing the step up in basis.
- Check Your Beneficiaries: Make sure your high-growth assets (like stocks) are going to heirs who will benefit from the step up, while your "tax-heavy" assets (like IRAs) are handled with an understanding of the future tax hit.
- Consult a Pro: If you live in a community property state, ensure your living trust is drafted as a "Joint Community Property Trust" to guarantee that double step up.
- Evaluate 2026: With the TCJA sunset coming, the rules around how much you can pass on tax-free are changing. Now is the time to see if your current plan relies on exemptions that might not exist in two years.
The step up in basis at death isn't just a loophole; it’s a fundamental pillar of how wealth is preserved across generations in the United States. Ignoring it is like leaving a massive pile of money on the table—money that your family, not the government, should probably keep.