When someone passes away and leaves assets to their heirs, one of the most overlooked but powerful tax benefits that can come into play is the step-up in basis. This tax rule can significantly reduce capital gains taxes for heirs and makes a big difference in estate planning and wealth transfer strategies.
What Is a Step-Up in Basis?
“Basis” is the amount you originally paid for an asset—essentially, its cost for tax purposes. When you sell an asset, the difference between the sale price and the basis is considered a capital gain (or loss), and you may owe taxes on that gain.
A step-up in basis means that when someone inherits an asset, the asset’s cost basis is adjusted—or “stepped up”—to its fair market value (FMV) on the date of the decedent’s death. In California, community property assets can get a double step up in basis, meaning that spouses who own community property assets can get a full step up on both halves of the community property at the first death.
For example:
- Let’s say your father bought a house 30 years ago for $300,000.
- When he passes away, the home is worth $1,000,000.
- If you inherit the home, your basis becomes $1,000,000—not the original $300,000 he paid.
- If you sell the house soon after for $1,100,000, you only owe taxes on the $100,000 gain, not the $710,000 difference from the original purchase.
What is a Double Step up in Basis?
In most states (which follow common law property rules), when one spouse dies, only the decedent’s share of jointly owned property receives a step-up in basis. The surviving spouse keeps their original basis for their half.
But in community property states, both the deceased spouse’s share and the surviving spouse’s share of community property get a step-up in basis to the fair market value on the date of death. This is referred to as a double step-up in basis. California is one of seven community property states.
Why Is the Step-Up in Basis Important?
- Reduces Capital Gains Taxes
Heirs may avoid significant capital gains taxes when they sell inherited assets that have appreciated in value. - Simplifies Tax Reporting
Instead of trying to track down decades-old purchase prices, heirs can use the fair market/appraised value as of the date of death. - Preserves More Wealth
The step-up in basis helps preserve family wealth by minimizing tax liability, making it a crucial consideration in estate planning.
How to Establish the New Basis
To take advantage of the step-up in basis, it’s important to accurately establish the fair market value of the inherited assets as of the date of death. Here’s how it’s typically done:
1. Real Estate
- Appraisal: The most reliable method is to hire a certified real estate appraiser to assess the property’s value as of the date of death.
- Comparable Sales: If a formal appraisal isn’t done at the time, you may use recent comparable sales data to estimate the value, but this may be less defensible if challenged by the IRS.
- Retrospective Appraisal: If the step-up wasn’t documented at the time, an appraiser can often provide a “retrospective” valuation based on the market at the date of death.
2. Brokerage Accounts
- Date of Death Valuation: The brokerage firm can typically provide a statement showing the value of each security on the date of death.
- Average Price: For stocks, the IRS generally allows you to use the average of the high and low prices on the date of death.
- Alternative Valuation Date: The estate’s executor may elect to use an alternate valuation date (six months later), but only if it reduces both the value of the estate and the estate tax owed.
The step-up in basis can be a powerful tax-saving tool for heirs, but it requires careful documentation. Whether you’re managing a loved one’s estate or planning your own, understanding how this rule works—and how to document the new asset values—is key to preserving wealth across generations.
Special Considerations for LGBTQ Married Couples
Many of our clients have been together for decades but only married for the past 15 years or less. Often they have bought homes or invested in assets prior to marriage. Because only married couples can have community property, even if both names are on the deed or the account, the couple technically owns jointly held separate property and it is not considered community property. In order to get the double step up in basis, the asset needs to be “transmuted” to community property. Also many married couples still have separate revocable trusts. In many cases, they should consider having a joint trust and possibly transmuting the assets in order to take advantage of the tax laws afforded to married couples.