Stepped-up basis (also called a step-up in basis) refers to the resetting of an inherited asset's cost basis to its fair market value at the decedent's date of death, rather than the decedent's original purchase price.
Why it matters: If a decedent purchased stock for $10,000 that is now worth $100,000, the heir receives a cost basis of $100,000 — not $10,000. If the heir immediately sells, the capital gain is $0 (not $90,000). The $90,000 of appreciation permanently escapes income tax.
Legal basis: IRC Section 1014.
How it works: - Asset passes to heir at death. - New cost basis = FMV at date of death (or alternate valuation date — 6 months after death — if elected by estate for estate tax purposes). - Heir can immediately sell without capital gains tax on pre-death appreciation. - If heir holds and the asset appreciates further, only the post-death appreciation is taxable.
Alternate valuation date: The estate may elect to use FMV 6 months after the date of death instead (only if it reduces both estate value AND estate tax).
Exceptions — no step-up: - Assets held in an IRA or 401(k) (these are income in respect of a decedent — IRD). - Some community property states have special rules; community property may receive a double step-up. - Gifts (no step-up; carryover basis applies).
Step-down: If the inherited asset has declined in value, the basis steps DOWN to the FMV at death (a step-down, creating a built-in capital loss).
> Exam tip: Stepped-up basis eliminates pre-death capital gains — a cornerstone of estate planning. Key distinction: IRAs get no step-up (IRA withdrawals are ordinary income). Community property may receive a full step-up on both halves.