The step-up in basis provision adjusts the value, or “cost basis,” of an inherited asset (stocks, bonds, real estate, etc.) when it is passed on, after death. This often reduces the capital gains tax owed by the recipient. The cost basis receives a “step-up” to its fair market value, or the price at which the good would be sold or purchased in a fair market. This eliminates the capital gain that occurred between the original purchase of the asset and the heir’s acquisition, reducing the heir’s tax liability.
How Does Step-Up in Basis Work?
The purchase price of an asset is typically referred to as the asset’s basis. Capital gains, or losses, refer to the difference between an asset’s purchase price (basis) and its value at the time of sale. It is not until a person realizes a capital gain (sells an asset for a profit) that capital gains taxes are due.
Some assets are held for generations and passed from their original owners to heirs. If these assets are never sold, they are never subject to capital gains taxes. If the heir chooses to sell the asset, any tax would be assessed on the new basis, meaning only appreciation after the asset had been inherited would face capital gains tax.
While the provision can help reduce the burden of the capital gains tax, it does not apply to the estate tax.
The Trade-Offs of Repealing Step-Up in Basis
Step-up in basis discourages people from realizing capital gains and reduces compliance costs for heirs because tracking cost basis of long-held assets, especially from decedents, can be difficult.
While it is less than neutral for capital gains to entirely escape taxation, as can occur due to step-up in basis, the policy also mitigates what would otherwise be a significant effective tax rate on saving by preventing taxpayersfrom having to pay both estate and capital gains taxes on the same inherited asset.
Repealing step-up in basis would make the tax code more progressive and would also encourage capital gains realization. As our model shows, revenues would increase and those in the top income groups would pay more relative to current law.
Economic Effects
- -0.1% Gross Domestic Product
- -0.2% Gross National Product
- -0.1% Capital Stock
- -8k Full-Time Equivalent Jobs
- -0.1% Wage Rate
Budgetary Effects
- $124.18 Billion Static 10-Year Revenue
- $118.46 Billion Dynamic 10-Year Revenue
Distributional Effect of Eliminating Step-up in Basis on Capital Gains| Income Group | Percent Change in After Tax Income |
|---|
| Conventional, 2022 | Conventional, 2031 | Long Run Dynamic |
|---|
| 0% to 20% | 0% | 0% | -0.1% |
| 20% to 40% | 0% | 0% | -0.1% |
| 40% to 60% | 0% | 0% | -0.1% |
| 60% to 80% | 0% | 0% | -0.1% |
| 80% to 100% | -0.2% | -0.1% | -0.2% |
| 90% to 95% | 0% | 0% | -0.1% |
| 95% to 99% | < -0.05% | < -0.05% | -0.1% |
| 99% to 100% | -0.5% | -0.5% | -0.5% |
| Total | -0.1% | -0.1% | -0.1% |
| Source: Tax Foundation General Equilibrium Model, April 2021 |
Repealing step-up in basiswould result in alarger negative effect on national income (GNP) than output (GDP) since the resulting reduction in domestic saving would attract inflow of foreign investment. After accounting for economic effects, after-tax income would drop at all income levels, with the largest effects felt by the top 1 percent.
While repealing step-up in basis would raise substantial revenue relative to current law, it would reduce national saving and total wealth, increase compliance costs for the government and taxpayers, and shift the tax code from taxing consumption—illustrating that every tax policy change comes with distinct trade-offs.
Eliminating the policy without changing the estate tax could also increase the tax burden on capital and increase compliance burdens for taxpayers.
Stay updated on the latest educational resources.
Level-up your tax knowledge with free educational resources—primers, glossary terms, videos, and more—delivered monthly.
Subscribe
FAQs
A step-up in basis happens when an asset's cost basis is reset to match the property's fair market value (FMV) when an heir's benefactor dies rather than when the asset was purchased.
What is the IRS rule on stepped-up cost basis? ›
A step-up in basis resets the cost basis of an appreciated inherited asset for tax purposes. The cost basis for heirs is raised to the asset's market value on the prior owner's date of death, reducing future capital gains taxes.
What is the step-up basis loophole? ›
Robert's son sells these shares for $300,000. He owes no taxes on this sale because, as far as the IRS is concerned, he didn't make a profit off this sale. The stepped-up basis loophole allows someone to pass down assets without triggering a tax event, which can save estates considerable money.
What assets do not qualify for a step-up in basis? ›
The appreciation during the deceased's lifetime goes untaxed. Assets affected by the stepped-up basis rules include securities, artwork, bank accounts, business interests, investment accounts, real estate and personal property. However, these rules don't apply to retirement assets such as 401(k) plans or IRAs.
What is the 6 month rule for step up basis? ›
For inheritances, the basis is the fair market value of the asset at the time of the donor's death (or six months afterward, if the executor elects the alternative valuation date). This is the stepped-up basis).
How do you take advantage of step up basis? ›
Gifts of appreciated stock or real estate while the owner is still living typically retain the owner's cost basis. If instead the asset is transferred upon the owner's death, it gets a step-up in basis and the recipient is never taxed on the capital gain accrued during the original ownership period.
Do I need an appraisal for stepped-up basis? ›
Proving Your Cost Basis
If a joint owner of property dies, you should get the property appraised to show the value at the time it is stepped up in basis. Be sure to save the documentation so you can use it later.
How does IRS verify cost basis? ›
The IRS expects taxpayers to keep the original documentation for capital assets, such as real estate and investments. It uses these documents, along with third-party records, bank statements and published market data, to verify the cost basis of assets.
What cannot be included in the cost basis of a main home? ›
The cost includes the cost of materials, equipment, and labor. However, you may not add the cost of your own labor to the property's basis. Add the interest you pay on construction loans during the construction period, but deduct interest you pay before and after construction as an operating expense.
How do you get rid of the stepped-up basis? ›
There are two main ways to close the stepped-up basis loophole: tax capital gains at death, or replace stepped-up basis with a carryover basis.
Here are five ways to avoid paying capital gains tax on inherited property.
- Sell the inherited property quickly. ...
- Make the inherited property your primary residence. ...
- Rent the inherited property. ...
- Disclaim the inherited property. ...
- Deduct selling expenses from capital gains.
Specifically, when married couples own community property and one spouse dies, you don't just get a step-up for the part owned by the deceased spouse. You get a Step-Up in Basis for the entire community property. (See IRS Publication 555 in March of 2020.)
Do joint accounts get stepped-up basis? ›
Step-Up in Basis for Joint Accounts
In a joint account, half of the assets are deemed to be owned by each party. This is common when married people own assets together. If a couple has a joint account and spouse A dies, half of the account deemed to belong to spouse A gets a step-up in basis.
How to calculate a step-up in basis? ›
How Is Step-Up In Basis Calculated? The step-up in basis is the difference between an asset's current value and its cost basis at the time it was purchased by the original owner.
What is an example of a stepped up cost basis? ›
Under a stepped-up basis, Sarah would only pay capital gains taxes on the $10 gains between inheritance and selling the stocks ($30-$20=$10). If the stepped-up basis did not exist, Sarah would have to pay capital gains taxes on the $20 gains between John's purchase price and selling the stocks ($30-$10=$20).
What is the one step up rule? ›
As a result, the government passed a law commonly referred to as the “Step-Up in Basis” rule. Section 1014 of the Internal Revenue Code states that if a person holds property at the time of his or her death, it will receive a new basis equal to the fair market value of such property at the person's date of death.
Is the step-up in basis unlimited? ›
The new criterion is not unlimited, and it allows step-up in basis under two basic conditions.
What is an example of step down basis? ›
The new owner would take that asset with a new lower (stepped-down) basis. This depends on the value as of the date-of-death of the owner compared to the price the owner originally purchased the asset. Example: Dad was convinced that AOL was going to make a comeback. He bought it for $50,000 and it's now worth $10,000.
Do inherited stocks get a step-up in basis? ›
Inherited stock, unlike gifted securities, is not valued at its original cost basis—a term used by tax accountants to describe the original value of an asset. When an individual inherits a stock, its cost basis is stepped up to the value of the security, at the date of the death.
