Step-Up in Basis: How Your Heirs Inherit Investments Without Paying Tax on Decades of Gains

When your heirs inherit your appreciated stock, real estate, or brokerage account, they don’t owe capital gains tax on the growth that happened while you owned it. Instead, their tax basis—the value they use to calculate gains when they sell—automatically adjusts to what the asset was worth on the day you died. This adjustment is called a step-up in basis, and it can erase decades of tax liability in a single stroke.

If you bought a stock for $50,000 thirty years ago and it’s worth $500,000 when you die, your heir’s basis is $500,000. If they sell immediately for $510,000, they owe tax on just $10,000—not the $450,000 of growth you accumulated. That’s the power of the step-up, and it’s one of the most valuable legal tax advantages in the entire U.S. tax code.

How step-up in basis works: the mechanics

The step-up is governed by IRC Section 1014, which says that when you inherit property from a decedent, your cost basis becomes the fair market value of that property on the date of death. That fair market value is almost always determined by an appraisal or estate account valuation done shortly after death.

Here’s the concrete example: imagine your parents bought their home in 1985 for $150,000. It’s now worth $800,000. When your parent dies:

• Your cost basis for that home is $800,000 (the stepped-up value), not $150,000
• If you sell it six months later for $810,000, your taxable gain is $10,000
• You owe capital gains tax only on those six months of appreciation, not the prior 40 years

The step-up applies to nearly every type of capital asset you might inherit:

• Individual stocks and bonds
• Mutual funds and ETFs in taxable brokerage accounts
• Real estate (primary homes, rental properties, farmland, commercial buildings)
• Collectibles and art
• Ownership stakes in private businesses
• Investment partnerships

This is why appreciated assets sitting in a brokerage account are often held until death rather than gifted during life. The tax math is brutal for lifetime gifts.

Why gifting kills the step-up: carryover basis

When you gift appreciated property to someone during your lifetime, they inherit your original cost basis—not a stepped-up one. This is called “carryover basis,” and it’s the opposite tax outcome.

If you gift that $500,000 stock to your child while you’re alive (when your cost basis is $50,000), your child’s basis is $50,000. When they sell it, they owe capital gains tax on the full $450,000 of appreciation—the gain that happened entirely while you owned it.

Many people think gifting appreciated assets early avoids tax. It does not. It actually defers and concentrates the tax burden on your heirs. For highly appreciated assets, holding until death is almost always better—especially if your estate is below the federal exemption.

What the step-up does NOT cover

The step-up in basis is powerful, but it has hard limits. It does not apply to retirement accounts—and this is where many people trip up in their estate planning.

Traditional IRAs and 401(k)s: These accounts get no step-up at all. They are “income in respect of a decedent” (IRD), so your heirs owe ordinary income tax on withdrawals just as you would have (see Inherited IRA and the SECURE Act 10-Year Rule for withdrawal timing). There is no basis reset—every taxable dollar stays taxable to your heirs.

Health Savings Accounts (HSAs): If you die with money in an HSA, your non-spouse heirs inherit taxable income, not tax-free withdrawals. This is the HSA inheritance tax trap many people don’t see coming.

Income in respect of a decedent (IRD): This includes accrued interest, unpaid salary, and other income earned by you but not yet paid or reported. IRD is taxed to your heirs at ordinary rates, even if it passes through your estate.

Debt-financed property: The basis step-up applies to the property’s full fair-market value at death—it is not reduced to your equity. Your heirs get a full stepped-up basis and separately take on the outstanding debt (the mortgage doesn’t shrink the step-up).

This is precisely why mapping which assets go where matters so much. A $500,000 traditional IRA is very different tax-wise from a $500,000 brokerage account, even though both pass to the same heir.

The community property double step-up: a strategic advantage for married couples

If you’re married and live in a community property state, there’s an additional layer to the step-up that can be extremely valuable: both spouses’ shares of jointly owned community property receive a full step-up at the first spouse’s death.

Community property states include California, Washington, Texas, Arizona, Idaho, Louisiana, Nevada, New Mexico, and Wisconsin.

Here’s the difference:

Common-law state (like New York): When one spouse dies, only their half of jointly owned property steps up. The surviving spouse’s half keeps the original cost basis.

Community property state: When one spouse dies, both halves step up to current fair market value. This is called the double step-up.

Example: A married couple in California buys a rental property in 2000 for $400,000. It’s now worth $1,000,000. The wife dies.

In California, the entire $600,000 gain disappears for tax purposes. In New York, only the wife’s $300,000 share does. The double step-up can be worth hundreds of thousands of dollars in avoided capital gains tax on highly appreciated marital property.

This is not a reason to move to California, but it is a reason to understand your state’s rules if you own significant appreciated assets as a couple.

New York considerations: no portability, and the estate tax cliff

If you live in New York, the step-up works as described above. However, New York also has its own estate tax separate from the federal one, and the rules are harsher.

As of 2026, New York’s estate tax exemption is $7,350,000 per person. However, New York does not allow portability—meaning when the first spouse dies, the surviving spouse cannot elect to use the unused exemption. The surviving spouse can only use their own exemption.

Worse, New York has a cliff: if your estate exceeds approximately 105% of the exemption (about $7,717,500), you lose the entire exemption and the estate is taxed from the first dollar. Note a common misconception here: the step-up does not reduce your New York (or federal) estate tax. Your estate is taxed on the assets’ full date-of-death value regardless of basis. The step-up is an income-tax benefit—it spares your heirs the capital-gains tax on the growth during your life.

If you have $10,000,000 in assets—$6,000,000 of it unrealized gains in a stock portfolio—your New York estate tax is calculated on the full $10,000,000 date-of-death value; the unrealized gains don’t lower it. Separately, your heirs’ income-tax basis resets to that $10,000,000, so they avoid capital-gains tax on the $6,000,000 of growth. This is why asset mapping and beneficiary designations become more urgent when you have significant appreciated assets and live in a high-tax state.

Holding appreciated assets as part of your estate plan

The step-up in basis is not just a tax technicality—it’s a core part of how estate plans are built for people with significant appreciated assets. It’s one reason why the financial order of operations ends with your estate plan: your will, trusts, and beneficiary designations determine not just who gets what, but how much tax your heirs will owe.

For many families, the strategy is simple: hold appreciated stock, real estate, and other capital assets until death, then pass them through your estate to heirs at stepped-up value. This is especially powerful if your estate is below the federal exemption ($15,000,000 per person in 2026) and avoids both income tax and estate tax.

For others, holding appreciated assets creates an estate tax problem in states like New York. In those cases, the strategy might involve strategic charitable giving, lifetime gifts to reduce taxable estate, or trusts designed to pass the stepped-up assets to heirs in a tax-efficient way. This is where professional estate planning becomes valuable—understanding which strategy fits your specific situation.

The step-up is legal, permanent, and one of the most valuable tax advantages available. Building your estate plan around it—rather than against it—is one way to ensure your heirs inherit as much as possible.

When you map your money through the Money Roadmap, you are building the path your assets will take after you die. Knowing whether each asset gets a step-up, stays subject to ordinary income tax, or passes through a beneficiary designation determines how much your heirs actually keep. That’s the estate planning connection: your financial strategy during life determines your heirs’ tax bill after.