Updated on December 22, 2025
What is Step Up Tax Basis and Why It Matters for Heirs?
If you have inherited real estate or are planning your estate with future generations in mind, there is one tax concept that can significantly affect how much wealth is ultimately transferred: step-up taxation.
For many families, step‑up taxation works alongside tools like revocable and irrevocable trusts to shape an overall estate plan.
Step-up taxation is a provision in U.S. tax law that can reduce, and in many cases eliminate, capital gains tax when inherited property is sold. It is formally governed by Internal Revenue Code Section 1014, which determines how the value of inherited assets is treated for tax purposes.
Under this rule, the cost basis of inherited property is adjusted to its fair market value at the time of the original owner’s death, rather than the price the decedent originally paid. For heirs, this adjustment can translate into substantial tax savings, especially when dealing with long-held assets such as real estate, stocks, or other appreciating investments.
This is not a loophole or an aggressive tax strategy. Step-up in basis is a core component of estate and inheritance planning, and it directly influences how capital gains are calculated when inherited property is later sold. When applied correctly, it can prevent decades of accumulated appreciation from being taxed at the time of transfer.
In the sections that follow, I will walk through how step-up taxation works under the law, explain the mechanics using a real-world example, and outline why it plays such a critical role in property inheritance and long-term estate planning.
It also interacts closely with California probate procedures when property passes through a decedent’s estate.
Key Takeaways: Step‑Up in Basis for Inherited Property
- Step‑Up Instructions – Heirs generally “get” a step‑up in basis automatically when they inherit qualifying assets; the cost basis resets to the property’s fair market value on the decedent’s date of death under IRC §1014, which is then used to calculate any future capital gains.
- Functionality – Step‑up in basis wipes out unrealized appreciation that occurred during the original owner’s lifetime, so if the heir sells the asset close to its value at death, there may be little or no capital gains tax due on that sale.
- Spouse’s Basis – In community property states like California, both halves of community property can receive a step‑up in basis when the first spouse dies, which can significantly reduce capital gains if the surviving spouse later sells or refinances the property.
- Cost Basis Adjustment – The step‑up is simply a cost‑basis adjustment: the “original cost basis” (what the decedent paid) is replaced with the “stepped‑up basis” (fair market value at death), and this new number becomes the starting point for tax calculations on inherited real estate, stocks, or business interests.
- Step‑Up Timing – The adjustment occurs at the owner’s death, not when the heir eventually sells, so planning decisions about gifting versus inheriting, using trusts, and coordinating with probate and title changes should all be made with that timing in mind.
Breaking Down IRC Section 1014: Step-Up in Basis Explained
To fully understand step-up taxation, it’s essential to look at the tax code that governs it: Internal Revenue Code §1014.
This section of the code states that the basis of property inherited from a decedent is typically reset to its fair market value at the date of the decedent’s death. This new valuation becomes the starting point — or “stepped-up basis” — for calculating capital gains if the inheritor later sells the asset. Before any sale, heirs often must update legal title to the property after the original owner’s death.
Here’s the core impact:
Original Cost Basis: The price originally paid for the asset by the decedent.
Stepped-Up Basis: The value of the asset at the time of death, which becomes the new basis for the inheritor.
By resetting the basis to the current market value, Section 1014 effectively erases the unrealized capital gains that would otherwise be taxed if the asset had been sold during the decedent’s lifetime.
This treatment applies to a wide range of asset classes, including:
- Real estate
- Marketable securities (like stocks and bonds)
- Business interests
- Personal property, in some cases
This provision has made step-up in basis a central pillar in wealth transfer planning, especially in families with generational property or significant investment portfolios. It allows heirs to minimize or avoid capital gains taxes when selling inherited assets — provided they understand how to apply it.
For more legal context, you can view the full text of IRC §1014 at Cornell Law’s Legal Information Institute
Real-Life Example of Step-Up in Basis
To see the power of step-up taxation in action, let’s walk through a simple but realistic scenario involving inherited real estate.
Let’s say your grandparent purchased a property in 1950 for $200,000. At the time of your grandparent’s death, the property is worth $2,000,000. Before your grandparent passed away, your grandparent’s cost basis would be $200,000. If they sold the property before their death for $2,000,000, $1,800,000 would be subject to capital gains tax (the difference between the purchase price and their cost basis).
On the other hand, if you inherit the property, which is currently valued at $2,000,000, and you choose to sell the property, Internal Revenue Code Section 1014 gives you a “step-up” in basis. In other words, your cost-basis is equal to the fair market value of the property at the person’s death—here, that would be $2,000,000—and not the cost basis of the decedent. Thus, if you, as the inheritor, sell the property for $2,000,000, you would be liable for $0 in capital gains tax (the difference between the purchase price and your cost basis).
In some cases, heirs must also resolve old liens or title defects before marketing inherited real estate.
Why Step-Up Taxation Should Be Part of Your Estate Planning Strategy?
Understanding the mechanics of step-up in basis is one thing — but integrating it into your broader estate planning strategy is where real financial impact happens.
When managing or inheriting high-value assets such as investment properties, equities, or closely held business interests, step-up taxation can serve as a powerful tool to preserve generational wealth and minimize future tax exposure.
However, this tax advantage doesn’t exist in a vacuum. Step-up interacts with other components of federal and state tax policy, including:
- Estate Tax: Applies to estates exceeding the federal exemption threshold (which adjusts annually). Even with step-up in basis, an estate above this limit may still trigger estate tax liability.
- Inheritance Tax (in certain states): Unlike estate tax, this is assessed on the beneficiary, and though not based on capital gains, it still affects the net value received.
This layered complexity is exactly why step-up taxation should be considered early in any estate or wealth transfer plan. While it may help eliminate capital gains tax, the overall tax liability — including estate or inheritance tax — can shift depending on asset types, location, and valuation thresholds.
At Schorr Law, our real estate litigation and ownership dispute attorneys help clients navigate these intersections between property law, tax policy, and inheritance strategy.