Stepped-Up Basis at Death

Definition of Basis: In most cases, a taxpayer’s basis in an item of property is determined by reference to the cost of acquiring the property (referred to as a cost basis).

Importance of Basis: Basis is an income tax benefit waiting to be used. The gain or loss realized by a taxpayer on the sale of property is measured by the difference between the amount realized and her adjusted basis in the property. The higher the property’s basis, the lower the taxable gain when the property is sold, and vice versa.

Example: Albert owns a parcel of real estate with a basis to Albert of $3,000. Were Albert to sell the property for $10,000, the taxable gain on the sale would be calculated as follows:

Sales Proceeds $10,000
Less: Basis (3,000)
Taxable Gain on Sale $7,000

Basis of Property Acquired by Gift: The basis of property acquired by gift is generally the donor’s adjusted basis in the property at the time of the transfer (referred to as a carryover basis). In the above example, if the parcel were gifted to a friend rather than sold, the property’s basis in the hands of the recipient would remain $3,000.

Basis of Property Acquired from Decedent: The basis of property acquired from a decedent is generally its fair market value on the decedent’s date of death. This usually results in a stepped-up basis where the property has an inherent gain. Yet, items of “income in respect of a decedent” are not eligible for stepped-up basis.

Example: Same facts as above example, except that Albert does not sell the property. Instead, he holds it until his death, when the property has a fair market value of $10,000. Pursuant to Albert’s will, the property passes to Albert’s daughter, who immediately sells the property for its fair market value. Due to stepped-up basis, the daughter recognizes no taxable gain, calculated as follows:

Sales Proceeds $10,000
Less: Stepped-up Basis (10,000)
Taxable Gain on Sale $0

Obviously, the basis step-up on death can be a tremendous income tax benefit.

Note: Special rules apply to prevent a taxpayer from receiving a stepped-up basis in appreciated property by transferring such property to an individual facing imminent death. Special rules also apply to determine the basis of property held in a joint tenancy (with a right of survivorship).