How to Use a "Step-Up in Basis" to Save Thousands on Inherited Stock

When you inherit stock or other investment assets, you're getting more than just the property itself—you're potentially getting a massive tax break. The step-up in basis rule is one of the most powerful (and underutilized) tax provisions in the Internal Revenue Code, and it can save your heirs thousands of dollars in capital gains taxes. Here's how it works and why it matters for your family's financial future.

What Is a Step-Up in Basis?

The step-up in basis is a tax rule that adjusts the cost basis of inherited assets to their fair market value on the date of the original owner's death.^[1] Think of "basis" as your starting point for calculating capital gains taxes. When you inherit an asset, the IRS essentially "steps up" that starting point to what the asset was worth when you received it, not what the previous owner originally paid for it.^[2]

Here's why this matters: capital gains taxes are calculated on the difference between what you paid for an asset and what you sell it for. Without the step-up in basis rule, heirs would inherit the original owner's cost basis and potentially face enormous tax bills on gains that accrued long before they owned the asset. With the step-up rule, all that appreciation during the original owner's lifetime escapes taxation entirely.^[3]

The step-up in basis applies to a wide range of assets, including stocks, mutual funds, bonds, real estate, artwork, business interests, and investment accounts.^[4] However, it does not apply to retirement accounts like 401(k) plans or IRAs, which have their own tax treatment rules.^[4]

How the Step-Up in Basis Works: Real Examples

Example 1: A Simple Stock Inheritance

Let's say you bought XYZ Corp. stock 10 years ago for $100,000. When you pass away, the stock is worth $500,000. Your daughter inherits it.^[4]

Under the step-up in basis rule, your daughter's cost basis is adjusted to $500,000—the fair market value on the date of your death. If she sells the stock immediately, she owes little or no capital gains tax, even though the stock appreciated $400,000 during your lifetime.^[4]

Without the step-up rule, your daughter would inherit your original $100,000 basis. If she sold the stock for $500,000, she'd owe capital gains tax on the entire $400,000 gain—potentially $80,000 in taxes at the maximum 20% long-term capital gains rate.^[4]

Example 2: Continued Appreciation After Inheritance

Now let's say your daughter holds onto the inherited stock for two more years. During that time, it appreciates from $500,000 to $700,000. When she sells it, she only owes capital gains tax on the $200,000 gain that occurred after she inherited it.^[4]

At the 20% long-term capital gains rate, she owes $40,000 in taxes. Without the step-up in basis, her tax bill on the $600,000 total gain would have been $120,000—a difference of $80,000.^[4]

Why the Step-Up in Basis Exists

The step-up in basis is codified in Internal Revenue Code Section 1014 and serves an important purpose: it prevents double taxation on a deceased person's estate.^[5] Without this rule, the same appreciation would potentially be taxed both as part of the estate tax and again as capital gains when the heir sells the asset. The step-up provision eliminates this burden and makes inherited assets more practical for families to manage.

Strategic Estate Planning With the Step-Up in Basis

Hold Low-Basis Assets Until Death

One of the most important estate planning strategies is to hold onto assets with significant appreciation (low basis relative to current value) until your death, rather than gifting them during your lifetime.^[6]

Here's why: if you gift appreciated stock to your children while you're alive, they inherit your cost basis. They'll face capital gains tax on the entire appreciation when they sell. But if they inherit the same stock after your death, they get the stepped-up basis and avoid those taxes.^[6]

For example, if you purchased stock for $10,000 that's now worth $100,000, gifting it during your lifetime transfers your $10,000 basis to the recipient. When they sell it for $100,000, they owe capital gains tax on the $90,000 gain. But if they inherit it after your death, their basis steps up to $100,000, and only appreciation beyond that amount is taxable.^[6]

Annual Gifting Still Has Its Place

While holding appreciated assets until death offers tax benefits, strategic annual gifting can still make sense for other reasons—like reducing your taxable estate or helping family members during your lifetime. For 2025, you can gift up to $19,000 per person per year without triggering gift tax consequences, and if you're married, each spouse can make this gift independently.^[5]

The key is understanding the trade-off: you're giving up the step-up in basis benefit in exchange for other estate planning goals.

Capital Gains Tax Rates for Inherited Assets

When your heirs sell inherited assets, they'll pay capital gains tax on any appreciation that occurs after the date of death. The good news: inherited property is always treated as a long-term capital gain, regardless of how long the heir actually holds it.^[3]

Long-term capital gains rates for 2025 are:

• 0% for single filers with income up to $47,025
• 15% for single filers with income between $47,026 and $518,900
• 20% for single filers with income above $518,900

(Rates are slightly higher for married filing jointly and other filing statuses.)

Compare this to short-term capital gains, which are taxed at ordinary income tax rates as high as 37%—a massive difference.^[2]

What the Step-Up in Basis Does Not Cover

It's important to understand the limitations of the step-up in basis rule:

• Retirement accounts like 401(k)s and IRAs don't receive a step-up in basis. Beneficiaries inherit the original owner's cost basis and face income taxes on distributions.^[4]
• No step-up on lifetime gifts: If you gift appreciated assets during your lifetime, the recipient takes your basis, not a stepped-up basis.^[5]
• Income in respect of a decedent (IRD): Certain types of income earned by the deceased but not yet received don't qualify for step-up treatment.

Planning Considerations for 2026

As of 2026, the step-up in basis remains a powerful tool for estate planning. However, tax laws can change, and there have been ongoing discussions in Congress about modifying or eliminating this provision for very large estates. If you have significant appreciated assets, now is the time to review your estate plan with a qualified tax professional or estate planning attorney.

Consider:

• Documenting the cost basis of your assets for your heirs
• Reviewing your will or trust to ensure appreciated assets pass through your estate (rather than through beneficiary designations, which have different rules)
• Discussing with your heirs which assets they should hold versus sell after inheriting them

Next Steps: Protect Your Family's Financial Future

The step-up in basis is a legitimate tax benefit designed to help families transition assets across generations. By understanding how it works and planning strategically, you can help ensure that your heirs keep more of what you leave them.

Here's what to do now:

1. Review your current assets and identify which ones have significant appreciation
2. Document the original cost basis of your investments for your heirs
3. Consult with a qualified estate planning attorney or CPA to ensure your assets are structured to maximize the step-up benefit
4. Discuss your estate plan with your family so they understand the tax implications of inherited assets
5. Keep your estate plan updated as tax laws and your financial situation change

For more information on estate planning and tax strategies, visit the IRS website or consult with a tax professional who specializes in estate planning.