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Section 1014 Step-Up in Basis: Inherited Property, Fair Market Value at Death, Worked Example

By chrisomo

The Section 1014 step-up in basis resets the income tax basis of property acquired from a decedent to its fair market value on the date of death. That single adjustment can erase a lifetime of unrealized appreciation, because heirs who sell shortly after death recognize little or no capital gain. In community property states the benefit doubles, and the rule does not apply to income in respect of a decedent, two distinctions that drive most estate planning decisions around when and how to hold appreciated assets.

What is the Section 1014 step-up in basis?

Section 1014 governs the income tax basis of property that passes from a person who has died. The general rule is simple to state: the basis of property in the hands of the person acquiring it from a decedent is the fair market value of the property at the date of the decedent’s death (Section 1014(a)(1)). Because capital gain is the excess of sale proceeds over basis, resetting the basis to date-of-death value eliminates the gain that accrued during the decedent’s lifetime. An heir who sells the asset soon after death recognizes gain only on appreciation that occurs after death.

The adjustment runs both ways. If an asset is worth less at death than the decedent’s original cost, Section 1014 produces a step-down, fixing the heir’s basis at the lower date-of-death value and erasing the built-in loss. This is why holding a depreciated asset until death wastes the loss, while holding an appreciated asset until death captures the step-up.

The step-up exists because the same appreciation is generally subject to the federal estate tax at death. Rather than tax the gain twice, once through the estate tax on date-of-death value and again through the income tax on the heir’s eventual sale, Section 1014 wipes out the income tax on pre-death appreciation. For most estates, which fall under the estate tax exemption, the result is that a lifetime of gain escapes income tax entirely.

Who is affected by Section 1014

Section 1014 reaches anyone who acquires property from a decedent and the fiduciaries who administer the estate.

Heirs and beneficiaries

Any person who acquires property from a decedent by bequest, devise, inheritance, or other means listed in Section 1014(b) takes a basis equal to fair market value at death. This includes property passing through a will, through intestacy, or through certain trusts and beneficiary designations that cause the property to be included in the decedent’s gross estate.

Surviving spouses, especially in community property states

Surviving spouses are the largest beneficiaries of the rule because of the community property double step-up under Section 1014(b)(6). The nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), plus the elective community property regimes some states offer, let the surviving spouse step up both halves of community property when the first spouse dies.

Estates and fiduciaries

Executors and trustees must determine fair market value at the correct date, decide whether to elect the alternate valuation date under Section 2032, and identify which assets are IRD that do not receive a step-up. These determinations set the basis that heirs will use for years, so errors at the estate level propagate into every later sale. Fiduciaries also navigate the basis consistency reporting rules of Section 1014(f) and Form 8971.

How Section 1014 works (mechanics)

The basis determination follows a fixed order.

Step 1: Confirm the property is acquired from a decedent

Section 1014 applies only to property acquired from a decedent within the meaning of Section 1014(b), which lists the qualifying transfers, including property included in the gross estate and certain property passing under a power of appointment. Property the decedent gave away during life, or property held in a way that excludes it from the gross estate, generally does not get the step-up.

Step 2: Determine the valuation date

The default valuation date is the date of death (Section 1014(a)(1)). If the estate elects the alternate valuation date under Section 2032, the value is measured six months after death, or on the date the property is sold or distributed if that occurs within the six months (Section 1014(a)(2)). The alternate date can only be elected if it both decreases the value of the gross estate and decreases the estate tax, so it tends to be used in falling markets.

Step 3: Establish fair market value

Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, both with reasonable knowledge of the relevant facts (Treas. Reg. 20.2031-1(b)). Publicly traded securities use the mean of the high and low on the valuation date. Closely held businesses, real estate, and other illiquid assets require appraisal, and discounts for lack of marketability and control may apply, which both lower the estate tax value and lower the stepped-up basis.

Step 4: Apply the community property double step-up where relevant

If the property is community property and at least half its value is includible in the deceased spouse’s gross estate, both the decedent’s half and the surviving spouse’s half take a basis equal to fair market value at death under Section 1014(b)(6). In a common law state, by contrast, only the deceased spouse’s half of jointly held property steps up.

Step 5: Exclude income in respect of a decedent

Items that constitute income in respect of a decedent do not receive a step-up under Section 1014(c). IRD is income the decedent earned or was entitled to but had not yet recognized, such as a traditional IRA, unpaid wages, deferred compensation, or accrued interest. The recipient reports the IRD as income when received, with the same character it would have had to the decedent, and may claim a deduction for the estate tax attributable to the IRD under Section 691(c).

Section 1014 rules and limits

The table below collects the key provisions that govern the step-up.

Worked example

A widow inherits 10,000 shares of stock from her late husband. The couple bought the shares decades ago for $100,000, and on the date of his death the shares are worth $1,000,000. The couple lived in a common law state and held the shares as community-like joint tenancy that is not true community property.

In the common law setting, only the husband’s half steps up. His half had an original basis of $50,000 and a date-of-death value of $500,000, so it steps up to $500,000. The widow’s half keeps its original $50,000 basis. Her combined basis is the $500,000 stepped-up half plus the $50,000 original half, or $550,000. If she sells the shares for $1,000,000, her capital gain is $450,000.

Now move the same couple to a community property state. Under Section 1014(b)(6), both halves of the community property step up to fair market value at death. The widow’s basis becomes the full $1,000,000. If she sells for $1,000,000, her capital gain is zero. The community property double step-up eliminated the entire $900,000 of lifetime appreciation, where the common law treatment left $450,000 of gain exposed. That gap is the single largest reason community property planning matters for appreciated assets.

Recent changes (OBBBA and TCJA)

Section 1014 itself was not rewritten by the Tax Cuts and Jobs Act of 2017 or by the One Big Beautiful Bill Act signed July 4, 2025. The step-up rule, the alternate valuation date, the community property double step-up, and the IRD exclusion all remain as enacted. What changed is the estate tax backdrop that determines whether the step-up comes at a cost. The TCJA roughly doubled the federal estate and gift tax exemption, and that elevated exemption was scheduled to revert at the end of 2025.

The OBBBA addressed that cliff by setting the federal estate and gift tax exemption at a higher permanent level going forward, indexed for inflation, removing the threatened reversion to the lower pre-2018 amount. The practical effect for Section 1014 planning is that more estates fall under the exemption and pay no estate tax, yet their heirs still receive the full date-of-death step-up. That combination, no estate tax plus a full step-up, is the most favorable outcome the Code offers for appreciated assets, and it reinforces the planning instinct to hold low-basis assets until death rather than gifting them during life, where the donee takes a carryover basis with no step-up.

Common pitfalls

• Assuming all inherited assets step up. Income in respect of a decedent, such as a traditional IRA or unpaid deferred compensation, never receives a step-up under Section 1014(c) and is taxed when received.
• Missing the community property double step-up. In a community property state, both halves step up under Section 1014(b)(6), and treating only the deceased spouse’s half as stepped up overstates the surviving spouse’s gain.
• Gifting low-basis assets during life. A lifetime gift carries over the donor’s basis with no step-up, so gifting appreciated property forfeits the death-time basis reset that the donee would otherwise receive.
• Triggering the one-year gift-back rule. Gifting appreciated property to a dying person who returns it within a year denies the step-up under Section 1014(e), defeating a common planning gambit.
• Ignoring basis consistency reporting. The heir’s basis cannot exceed the value reported for estate tax purposes under Section 1014(f), and large estates must file Form 8971 to report basis to beneficiaries.
• Forgetting the step-down on depreciated assets. Holding a loss asset until death wastes the loss, because Section 1014(a)(1) steps the basis down to the lower date-of-death value.
• Overlooking the alternate valuation date interaction. The Section 2032 alternate date sets basis as well as estate value, and electing it in a falling market can reduce the heir’s stepped-up basis.

Frequently asked questions

What is a step-up in basis?

A step-up in basis is the reset of an inherited asset’s income tax basis to its fair market value at the decedent’s death under Section 1014(a). It erases the capital gain that accrued during the decedent’s lifetime, so heirs who sell soon after death recognize little or no gain.

Does every inherited asset get a step-up?

No. Property acquired from a decedent generally steps up, but income in respect of a decedent, such as a traditional IRA, unpaid wages, or deferred compensation, does not step up under Section 1014(c) and is taxed when the heir receives it.

What is the community property double step-up?

In a community property state, when the first spouse dies, both halves of community property step up to fair market value under Section 1014(b)(6). In a common law state, only the deceased spouse’s half steps up, leaving the survivor’s half at original basis.

What is the alternate valuation date?

Under Section 2032, an estate may elect to value assets six months after death (or at earlier disposition) instead of at the date of death. The election is available only if it lowers both the gross estate and the estate tax, and it also sets the heir’s stepped-up basis.

Is inherited property always long-term?

Yes. Property acquired from a decedent is treated as held long-term regardless of how long the heir actually holds it under Section 1223(9), so a sale shortly after death still receives long-term capital gain treatment.

How does the step-up interact with the estate tax exemption?

After the One Big Beautiful Bill Act set a higher permanent estate and gift tax exemption, most estates pay no estate tax yet heirs still receive the full step-up. That combination makes holding appreciated assets until death especially favorable compared with lifetime gifting.

Why is gifting appreciated property usually worse than inheriting it?

A lifetime gift gives the donee a carryover basis equal to the donor’s basis, with no step-up. Inheriting the same asset gives a date-of-death step-up, so transferring appreciated property at death rather than by gift typically saves substantial capital gains tax.

How does Section 1014 relate to partnership basis adjustments?

When a partner dies, the heir’s outside basis in the partnership interest steps up under Section 1014, but the inside basis of partnership assets does not adjust automatically. A Section 754 election lets the partnership step up the inside basis to match, aligning the two.

Does Section 1014 apply to qualified small business stock?

Inherited stock receives a date-of-death basis like any other asset. The interaction with Section 1202 matters because the QSBS gain exclusion runs on original holding and acquisition rules, and an heir’s stepped-up basis changes the gain that would otherwise be eligible for exclusion.