Stepped-Up Basis at Death: How IRC 1014 Eliminates Capital Gains on Inherited Assets

By Yarik Yarosh, CPA ·September 5, 2026 ·Updated October 18, 2026 ·10 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

The stepped-up basis at death is one of the most significant tax benefits in the Internal Revenue Code. Under IRC 1014, property acquired from a decedent receives a basis equal to its fair market value on the date of death. This means all unrealized appreciation that accrued during the decedent’s lifetime is permanently excluded from income tax. No capital gains tax is ever paid on the appreciation, no depreciation recapture is triggered, and the heir starts with a clean slate. For families that hold appreciated assets (particularly real estate, stocks, and business interests), the step-up can eliminate hundreds of thousands or millions of dollars in potential capital gains tax. The step-up applies to most assets included in the decedent’s gross estate for estate tax purposes (IRAs, 401(k)s, and other income in respect of a decedent are the big exception), including assets held in revocable trusts, jointly held property (to the extent included in the estate), and community property (both halves receive a step-up in community property states). Understanding how the step-up works is essential for estate planning, entity selection, and investment decisions, because strategies that maximize the step-up can produce dramatically different after-tax outcomes for heirs.

✓Key takeaway

How stepped-up basis works:

Concept	Rule
General rule	Inherited property basis = FMV on date of death (IRC 1014(a))
Alternate valuation date	Executor can elect FMV 6 months after death if it reduces the estate (IRC 2032)
Applies to	Most assets included in the decedent’s gross estate (not IRAs, annuities, or other income in respect of a decedent)
Capital gains eliminated	All appreciation from purchase to death is permanently untaxed
Depreciation recapture eliminated	No Section 1245 or 1250 recapture for the heir
Depreciation reset	Heir restarts depreciation from the new stepped-up basis
Stepped-down basis	If FMV at death is less than the decedent’s basis, the heir’s basis is stepped DOWN to FMV (loss is permanently lost)

Assets that receive a step-up:

Asset	Step-Up?
Stocks, bonds, mutual funds	Yes
Real estate (personal and investment)	Yes
Business interests (sole proprietorship, partnership with 754 election)	Yes
S-Corp stock (stock gets step-up; underlying assets do NOT without special rules)	Partial
Collectibles, art, jewelry	Yes
Personal property (vehicles, furniture)	Yes (but typically stepped down due to depreciation)
IRAs, 401(k)s, other retirement accounts	NO (income in respect of a decedent; no step-up)
Annuities	NO (income in respect of a decedent)

How does the stepped-up basis affect planning?

Hypothetical example

Round numbers. For current guidance, see IRS estate and gift tax overview. A business owner (age 75) holds the following assets:

Asset	Original Basis	Current FMV	Built-In Gain
Stock portfolio	$200,000	$1,500,000	$1,300,000
Rental property (original cost $300K, depreciation taken $200K)	$100,000	$800,000	$700,000
Primary residence	$150,000	$600,000	$450,000
Partnership interest (with IRC 754 election)	$50,000	$400,000	$350,000
S-Corp stock	$100,000	$500,000	$400,000
Traditional IRA	N/A	$600,000	$600,000 (all ordinary income)
Total	$600,000	$4,400,000	$3,800,000

If the owner sold everything during lifetime:

Asset	Gain	Tax Rate	Tax
Stock	$1,300,000	23.8% (LTCG + NIIT)	$309,400
Rental property	$700,000 ($200K at 28.8% (25% recapture + 3.8% NIIT) + $500K at 23.8%)	Mixed	$176,600
Primary residence	$450,000 - $500,000 exclusion (MFJ) = $0 taxable	0%	$0
Partnership	$350,000	23.8%	$83,300
S-Corp stock	$400,000	23.8%	$95,200
IRA (distribution)	$600,000	37% (top rate; less if not all of it falls in the top bracket)	$222,000
Total lifetime tax			$886,500

If the owner holds until death (step-up):

Asset	Heir’s Basis	Built-In Gain Eliminated	Tax Saved
Stock	$1,500,000 (FMV at death)	$1,300,000	$309,400
Rental property	$800,000 (FMV, depreciation recapture eliminated)	$700,000	$176,600
Primary residence	$600,000 (FMV)	$450,000	$0 (would have been excluded anyway)
Partnership (with 754 election)	$400,000 (FMV)	$350,000	$83,300
S-Corp stock	$500,000 (stock basis only)	$400,000 (but underlying asset basis unchanged without special treatment)	$95,200
IRA	NO step-up (IRD)	$0	$0
Total capital gains tax saved by step-up			$664,500

The heir inherits the non-IRA assets with a $3,800,000 basis (equal to FMV), can sell immediately, and pays $0 in capital gains tax. The IRA is the only asset that does not receive a step-up (it is taxed as ordinary income when distributed to the heir).

Entity comparison for step-up purposes:

Entity Type	What Gets a Step-Up at Owner’s Death
Sole proprietorship	All business assets (they are the decedent’s assets)
Partnership / LLC (with IRC 754 election)	The deceased partner’s share of ALL underlying partnership assets gets a step-up (IRC 743(b) adjustment)
Partnership / LLC (without 754 election)	Only the partnership interest itself gets a step-up; no adjustment to underlying assets until a triggering event
S-Corporation	Only the stock gets a step-up; the underlying corporate assets do NOT get a basis adjustment
C-Corporation	Only the stock gets a step-up; underlying corporate assets do NOT get a basis adjustment; but a 338 election can be made by the buyer

This is one of the most important entity selection considerations for business owners with significant built-in gain. A partnership or LLC with a 754 election in place provides a full step-up in all underlying assets at death, while an S-Corp does not.

“Swap till you drop” strategy (like-kind exchange + step-up):

Step	Action
1	Owner performs 1031 exchanges throughout lifetime (deferring capital gains on each sale)
2	Basis carries over from each property to the next, so the deferred gain keeps growing
3	Owner holds the final replacement property until death
4	Step-up at death eliminates ALL deferred gains from every prior exchange
5	Heir inherits property with FMV basis, can sell tax-free or begin new depreciation

Example:

Transaction	Sale Price	Deferred Gain	Basis
Original purchase			$200,000
1031 exchange #1 (sell for $500K, buy $500K replacement)	$500,000	$300,000	$200,000 (carryover)
1031 exchange #2 (sell for $800K, buy $800K replacement)	$800,000	$600,000	$200,000 (carryover)
1031 exchange #3 (sell for $1.2M, buy $1.2M replacement)	$1,200,000	$1,000,000	$200,000 (carryover)
Death (FMV = $1,500,000)			$1,500,000 (step-up)
Total gain permanently eliminated		$1,300,000
Tax savings (23.8%)		$309,400

Community property double step-up: In community property states (AZ, CA, ID, LA, NV, NM, TX, WA, WI), both halves of community property receive a step-up at the first spouse’s death:

Ownership Type	Step-Up at First Death
Community property (CP states)	100% of the property (both halves)
Joint tenancy (common law states)	Only the decedent’s 50% share
Tenancy in common	Only the decedent’s share

This means a surviving spouse in a community property state who inherits $2 million of community property stock (with a $200,000 basis) gets a full $2 million step-up, while a surviving spouse in a common law state with the same stock in joint tenancy gets a step-up on only half ($1 million step-up on the decedent’s half, $100,000 original basis on the survivor’s half).

Planning implications:

Strategy	Benefit
Hold highly appreciated assets until death	Step-up eliminates capital gains permanently
Use 1031 exchanges during lifetime, hold final property	Swap till you drop strategy
Choose partnership/LLC over S-Corp for appreciated assets	Full step-up in underlying assets with 754 election
Do NOT gift highly appreciated assets (gift carries over basis)	Gifts do NOT receive a step-up; the donee takes the donor’s basis
Spend IRA/401(k) first, preserve appreciated assets	IRAs do not get a step-up; appreciated assets do
Consider converting traditional IRA to Roth (pay tax now, Roth grows tax-free)	Qualified Roth distributions (after the Roth’s five-year period) are tax-free to heirs; avoids IRD issue

Illustrative numbers only, not a real client and not advice for your facts.

How do valuation discounts work for family business transfers?

When transferring a minority interest in a closely held business to family members, the fair market value can be reduced by a lack-of-control discount and a lack-of-marketability discount. These discounts reflect that a minority, non-publicly-traded interest is worth less than its proportional share of the total business value because the buyer can’t control operations or easily sell the interest. The combined effect can reduce the taxable value of a transfer substantially, lowering gift and estate tax exposure. The IRS frequently challenges aggressive discount claims, so a qualified business appraiser’s report is essential to defend the valuation. Under current law, they remain available when properly documented.

Should I use a revocable or irrevocable trust for estate planning?

A revocable living trust avoids probate and provides management continuity if you become incapacitated, but offers no tax benefits because the assets are still in your taxable estate. An irrevocable trust removes assets from your estate, potentially reducing estate tax, and can protect assets from creditors. The trade-off is control: you cannot easily modify or revoke an irrevocable trust. For most small business owners below the estate tax exemption ($15 million per person for 2026), a revocable trust paired with proper beneficiary designations is sufficient. Business owners above the exemption (or expecting to exceed it) should consider irrevocable structures like GRATs, SLATs, or intentionally defective grantor trusts.

Related guides:

How does the lifetime gift and estate tax exemption work for business owners?

The combined lifetime gift and estate tax exemption for 2026 is $15 million per individual ($30 million for a married couple that uses both spouses’ exemptions), meaning you can transfer this amount during life or at death without owing federal gift or estate tax. Gifts to individuals up to the annual exclusion ($19,000 per recipient for 2026) don’t count against your lifetime exemption and don’t require a gift tax return. The 2025 tax law (Public Law 119-21) replaced the scheduled sunset: the exemption is $15 million for 2026 and will be adjusted for inflation from 2027. Transferring discounted interests in a family business entity (LLC or FLP) can leverage the exemption because valuation discounts for lack of marketability and lack of control can reduce the taxable value of the transferred interest.

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Cite this page

Yarik Yarosh, CPA. "Stepped-Up Basis at Death: How IRC 1014 Eliminates Capital Gains on Inherited Assets." Blue Cloud CPA, September 5, 2026, updated October 18, 2026. https://bluecloudcpa.com/guides/small-business-tax-basis-step-up-death-irc-1014-estate-planning

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.