Step-Up in Basis at Death: When Holding Beats Selling

How the step-up works

When someone dies, the heirs' basis in inherited property is generally reset to its fair market value on the date of death (or the alternate valuation date, if the executor elects it). The rule is in IRC Section 1014(a). If an owner paid $1,000,000 for land now worth $5,000,000, the heirs start with a $5,000,000 basis. If they sell for that amount, there is little or no gain to report.

Because the basis is reset, the depreciation an owner claimed over the years is also wiped out as a recapture item. The heirs do not owe the 25 percent unrecaptured Section 1250 gain or Section 1245 ordinary recapture that the owner would have owed on a lifetime sale.

The step-up is an income tax rule. It does not reduce the value counted for federal estate tax. Those are two separate systems, and a hold decision has to look at both.

Rules that make or break the step-up

• Community property. Under Section 1014(b)(6), when one spouse dies, both halves of community property get a new basis, not just the decedent's half. For a California couple holding a low-basis asset as community property, the first death can reset the whole basis.
• Joint tenancy between spouses. Only the decedent's half is included in the estate under Section 2040(b), so only that half gets a new basis.
• Installment notes. Section 1014(c) excludes income in respect of a decedent. An unpaid installment note is exactly that under Section 691(a)(4). Once you sell on a note, the deferred gain survives your death and the heirs pay it as payments come in (with a deduction for estate tax attributable to it under Section 691(c)).
• Deathbed gifts back. Under Section 1014(e), if appreciated property is given to a person who dies within one year and it passes back to the donor (or the donor's spouse), there is no step-up.
• Completed gifts to a grantor trust. In Rev. Rul. 2023-2, the IRS ruled that assets in an irrevocable grantor trust that are outside the grantor's estate do not get a step-up at death.
• Suspended passive losses. At death, suspended passive losses are allowed only to the extent they exceed the step-up (Section 469(g)(2)), so part of a loss bank can disappear.

Who it fits, and who it does not

Good fit: owners in their late 70s or older, or in poor health, holding a low-basis asset that produces income they can live on. Owners with other liquid assets. Families who plan to keep the property, or who are comfortable selling it after the death.

Poor fit: owners who need the money now, who are tired of managing a business or a building, or whose asset could lose value (a business tied to the owner's personal relationships, a single-tenant building with a lease running out). A step-up on a lower value can leave the family worse off than paying tax on a higher value today. It also fits poorly when the estate is well above the federal exemption and the estate tax, not the income tax, is the larger bill.

Worked example

Assumptions (labeled, from the site's tax engine, 2026 law): married filing jointly, California residents, $150,000 of other ordinary income, investment land worth $5,000,000 with a $1,000,000 basis and no depreciation, sold for cash in 2026. California brackets are the latest table the engine carries.

If the owner instead holds the land and it passes to the heirs at the same $5,000,000 value, the heirs' basis becomes $5,000,000 and a sale at that price produces essentially no capital gain (selling costs aside). The $1,443,315 is not deferred; it is gone. What the family gives up is the use of the cash during the owner's life, and it takes on the risk that the land is worth less at death than today.

IRS stance and audit risk

The step-up is settled statutory law, not a strategy the IRS challenges as such. The audit points are valuation and consistency:

• Valuation. The new basis is the date-of-death fair market value. A qualified appraisal at death is the evidence for it. Overstating value to get a higher basis invites a fight on the later sale.
• Basis consistency. Under Section 1014(f) and Section 6035, an heir's basis cannot exceed the value finally determined for estate tax purposes, and executors who must file Form 706 report values to heirs on Form 8971.
• Ownership form. Whether an asset is community property, joint tenancy or trust property decides how much gets stepped up. Title documents and trust terms matter.

Estate tax: the other half of the decision

The One Big Beautiful Bill Act set the basic exclusion amount at $15,000,000 per person for 2026, indexed after that (Section 2010(c)(3); IRS: What's new, estate and gift tax). A married couple can shelter about $30,000,000 with portability. Above that, the federal rate is 40 percent. Several states, including Oregon, Massachusetts, Washington and New York, have their own estate taxes with much lower thresholds. For most sellers under the exemption, holding costs nothing in estate tax and removes the income tax. For larger estates, a hold keeps the full value in the estate, while a sale and a spend-down or a gifting plan may shrink it.

Costs and fees

Holding itself costs little in fees: a current will or living trust, title review (community property versus joint tenancy), and date-of-death appraisals. The real costs are economic: continued management, concentration risk, and no access to the sale proceeds. Owners who need cash without selling sometimes borrow against the asset (see cash-out refinance before a sale), which keeps the step-up but adds interest cost and debt risk.

How it compares with a Section 453 installment sale

A Section 453 installment sale spreads the tax over the years payments arrive, which can keep more of the gain in lower brackets and below surtax thresholds. But it starts the clock: the gain is locked in, and any unpaid balance at death is income in respect of a decedent with no step-up. A hold keeps the step-up but gives up the cash. Owners who want both often split the decision: sell part, hold part, or exchange into replacement property with a 1031 exchange and hold that until death, which carries the deferred gain into a property that can still be stepped up.

The right answer depends on age, health, need for cash, the asset's risk and the estate's size. That is what a side-by-side model shows.

Frequently asked questions