What Is a Step-Up in Basis?

Step-up in basis is a tax provision that adjusts the cost basis of an inherited asset to its fair market value on the date of the previous owner's death.

This adjustment is important because 澳洲幸运5官方开奖结果体彩网:the cost basis determines the taxes owed when the asset is sold. The cost basis starts with the asset's purchase price plus any additional costs incurred for improvements or maintenance over time.

Impact for the Beneficiary

When the market value of an inherited asset is higher at the time of the owner's death than its original purchase price, the cost basis (which was based on the original purchase price) rises. This reduces the 澳洲幸运5官方开奖结果体彩网:capital gains taxes owed if the asset is sold later.

However, if the market value of an asset has decreased since the owner's purchase, the asset's cost basis would step down instead of stepping up for heirs.

In practice, most inherited assets after death are stepped up, 𝓀not stepped down. This is because financial assets passed o🅘n to heirs are often long-term holdings that grow in value over the years.

The step-up in basis provision applies to various types of financial assets, including stocks, bonds, mutual funds, 澳洲幸运5官方开奖结果体彩网:real estate, and other tangible properties.

How Does Step-Up in Basis Work?

A step-up in basis resets the cost basis of an inherited asset from its purchase (or prior to inheritance) price to the asset's higher 澳洲幸运5官方开奖结果体彩网:market value on the date of the owner's death.

Example

Let's suppose Jane purchases a share of stock at $2 and dies when its market price is $15. Had Jane sold the stock before dying at $15, she (or her estate after her death) would be liable for capital gains tax on a gain of $13.

Instead, her heir's cost basis becomes $15 so that if the stock is later sold at that price no capital gains tax would be due. The tax that would have been incurred on the increase from $2 to $15 is effectively eliminated.

Step-Up in Basis in Community Property States

Residents of nine community property states, including California, can use the double step-up in basis rule. This 🌃allows a step-up in basis for community property—assets accumulated during marriage, excluding inheritances and gifts—for the surviving spouse.

In other states, assets owned solely by the surviving spouse do not receive the step-up in basis, while jointly owned assets receive only half the step-up in basis they would receive in a community property state.

Alaska, Kentucky, South Dakota, and Tennessee allow residents and non-residents to create community property trusts that qualify held assets for community property tax treatment, including the double step-up in basis rule, under the federal tax code.

Example

Consider Ann and Bill, a hypothetical married couple in a common-law state. They hold stock worth $200,000 in a joint brokerage account with a cost basis of $100,000 at the time of Bill's death.

Under common law principles, Ann would receive a step-up in basis on Bill's half of the account, valued at $100,000, but not on her half. Therefore, the tax basis for the stock would rise to $150,000 instead of $200,000, as it would in community property states.

Step-Up in Basis as a Tax Loophole

The step-up in basis tax provision has often been criticized as a tax loophole for wealthy families. The Congressional Budget Office (CBO) has estimated that over half the aggregate benefit accrues to the top 5% of taxpayers by income.

In 2024, the nonpartisan Peter G. Peterson Foundation estimated the tax revenues that the government would not receive due to the provision at:

• $58 billion in 2024
• $61 billion in 2025
• $64 billion in 2026
• $68 billion in 2027

Arguments for and Against

Some supporters have argued that eliminating the step-up in basis could discourage saving and result in 澳洲幸运5官方开奖结果体彩网:double taxation when combined with the federal estate tax.

But after the 2017 federal estate tax exemption doubled, only 0.04% of adult deaths in 2020 triggered estate tax liability.

In 2021, a proposal backed by former President Joe Biden and some Democrats to eliminate the step-up in basis for assets exceeding $2.5 million (plus $250,000 for a home) for a married couple failed to secure congressional approval.

The Bottom Line

The step-up in basis is a valuable tax provision that allows inherited assets to have their cost basis adjusted to their fair market value at the time of the previous owner's death.

This adjustment can significantly reduce capital gains taxes for heirs when they sell the asset. However, it has drawn criticism for benefiting primarily wealthy households because they can pass on substantial assets without incurring capital gains taxes.