Stepped-Up Cost Basis: Tax Mistakes to Avoid After a Death

If you are trying to understand stepped up cost basis and the mistakes to avoid after a death, start with this example:

Your parent bought a house in 1990 for $150,000. When your parent dies in 2024, the house is worth $550,000.

Without the stepped-up basis: If you inherited the house at your parent's original purchase price ($150,000) and sold it for $550,000, you would owe capital gains tax on $400,000 in gains. At a 15-20% federal rate plus state taxes, that could be $60,000-$100,000 in taxes.

With the stepped-up basis: You inherit the house at its fair market value on the date of death — $550,000. If you sell it for $550,000, your gain is $0. You owe zero capital gains tax.

That is the stepped-up basis. It "steps up" the cost basis of inherited assets from the original purchase price to the fair market value at the date of death. It is one of the most powerful tax provisions available to families, and the most common reason people lose this benefit is simply not knowing it exists.

Assets that DO get stepped up:

• Real estate (primary residence, vacation home, rental property, land)
• Stocks, bonds, mutual funds, ETFs
• Business interests (partnerships, LLCs, S-corps)
• Collectibles (art, antiques, jewelry, coins)
• Cryptocurrency
• Personal property (vehicles, equipment, etc.)

Assets that do NOT get stepped up:

• Traditional IRAs and 401(k)s — these are "income in respect of a decedent" and are taxed as ordinary income when withdrawn, just as they would have been for the deceased
• Annuities — similar to retirement accounts, the gain portion is taxed as ordinary income
• Items previously gifted within one year of death that return to the donor's estate

Most people don't know: Savings bonds (Series I, EE, HH) are an unusual case. The bond itself does not get a stepped-up basis, but the executor can choose to report all accrued interest on the deceased's final tax return. This can be beneficial if the deceased had low income in their final year.

This is one of the biggest tax advantages that many families in community property states do not know about:

In common law states (most of the country), only the deceased spouse's half of jointly owned assets gets a stepped-up basis. The surviving spouse's half retains its original basis.

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), both halves of community property get a stepped-up basis when one spouse dies.

Example: A married couple in California bought stock for $50,000. At one spouse's death, the stock is worth $500,000. In a common law state, only half gets stepped up — the new basis would be $275,000 ($25,000 original basis on the survivor's half + $250,000 stepped-up basis on the deceased's half). In California, the entire $500,000 gets stepped up. If the surviving spouse sells immediately, they owe zero capital gains tax.

The difference in this example: roughly $33,750-$45,000 in saved taxes.

This is the most common and most costly mistake. If you sell an inherited asset without first documenting its fair market value on the date of death, you may have no way to prove what your stepped-up basis was.

What to do:

• Real estate: Get a formal appraisal as of the date of death. This typically costs $300-$500 and is well worth it. You need the appraisal to report dated at the actual date of death, not the date you got around to ordering it.
• Stocks and publicly traded investments: Request a date-of-death valuation statement from the brokerage. This shows the market price on the exact date of death.
• Business interests: You may need a professional business valuation. This is more expensive ($2,000-$10,000) but essential for significant business interests.
• Personal property: For valuable items (art, antiques, jewelry), get a qualified appraisal.

Do not sell anything — especially real estate — until you have the date-of-death valuation documented and saved.

Even if you are not planning to sell right away, document the fair market value of every significant asset as of the date of death. If you sell the asset 5 or 10 years from now, you will need this documentation to prove your stepped-up basis.

The IRS can audit tax returns for up to 3 years after filing (6 years if there is a substantial understatement). If you sell an inherited asset years later and cannot document its value at the date of death, the IRS may challenge your basis and assess additional taxes.

What to keep:

• Formal appraisals
• Brokerage date-of-death statements
• Real estate comparable sales data from the date of death
• Property tax assessments (not definitive but supportive)
• Zillow/Redfin estimates printed on the date of death (supplementary, not primary documentation)

This is a critical distinction that many people (and even some accountants) get wrong:

Gifted assets: When someone gives you an asset while they are alive, you receive their original cost basis. This is called "carryover basis." If Mom gives you stock she bought for $10,000 that is now worth $100,000, your basis is $10,000. If you sell it, you owe taxes on $90,000 in gains.

Inherited assets: When you inherit the same stock after Mom dies, your basis is stepped up to $100,000 (the date-of-death value). If you sell it for $100,000, you owe zero.

Most people don't know: This distinction means that in some cases, it is actually better from a tax perspective to inherit an appreciated asset than to receive it as a gift. If a parent is considering transferring appreciated assets, the tax implications of a gift versus an inheritance can differ by tens of thousands of dollars. This is why gifting appreciated assets before death is sometimes called a "tax mistake" — though there are other valid reasons to make gifts.

The executor can elect to value the estate at an "alternate valuation date" — 6 months after the date of death instead of the date of death itself. This is typically used when the estate's value has declined significantly in the 6 months after death.

However, using the alternate valuation date affects the stepped-up basis for ALL assets in the estate, not just the ones that declined. If some assets went up and others went down, you need to calculate whether the alternate date is beneficial overall.

This election is only available for estates that are required to file a federal estate tax return (Form 706) — meaning estates above the $13.61 million exemption in 2024. For most estates, this does not apply.

When filing the deceased's final income tax return, make sure to use the correct holding period for any assets sold between the date of death and the end of the tax year. All inherited assets are treated as "long-term" capital gains regardless of how long the deceased actually held them.

Additionally, if the deceased sold assets earlier in the year, those transactions need to be reported at the deceased's actual basis (not the stepped-up basis, which only applies to the person who inherits).

1. Get date-of-death valuations for every significant asset. Do this as soon as possible while the data is readily available.
2. Request a date-of-death statement from every brokerage. Most firms will provide this automatically if you notify them of the death, but ask specifically.
3. Order a real estate appraisal. Make sure the appraiser values the property as of the date of death, not the date of the appraisal.
4. Store all documentation safely. Keep copies with the estate records, your personal tax files, and ideally in a digital format that will last.
5. Tell your tax preparer. When filing your return for the year you sell an inherited asset, make sure your CPA or tax software knows the asset was inherited and what the stepped-up basis is.
6. If you are in a community property state, document that. The full community property step-up is a valuable benefit, but you may need to demonstrate that the asset was community property.