Inheriting a home or stock often feels like a blessing, but then tax questions pop up, and you wonder what the true cost will be. A step-up in basis can shrink those taxes in a very real way. At Casey Lundregan Burns, P.C., we have guided Massachusetts families for more than 90 years, and we see this rule make a clear difference for heirs. Our goal here is simple: explain what a step-up in basis means and how it can affect your family.
What is Step-Up in Basis?
Step-up in basis is a tax rule that resets the cost basis of an inherited asset to its fair market value on the date the original owner dies. If the asset loses value, the basis can step down instead. The new number becomes your starting line for calculating capital gains taxes if you sell later.
This rule sits in Section 1014 of the Internal Revenue Code. In short, it resets past growth so you are taxed only on gains after the death date, not on the decades of growth that happened while your loved one owned the asset.
How Step-Up in Basis Works
Before any inheritance, an asset’s original basis is usually what the owner paid, plus closing costs, improvements, and certain adjustments. Think of a house with a new roof and kitchen. Those improvements add to the basis and reduce future taxable gain. The same idea applies to some investments with reinvested dividends.
Once inherited, the asset’s basis is changed to its fair market value on the date of death. If you sell later, you pay capital gains taxes only on the increase that happened after that date. Estates that file an estate tax return can sometimes use an alternate valuation date, six months after death, to lower both the estate value and the estate tax.
Step-Up in Basis Example
Let us use a simple story. A mother bought a Salem home for $50,000 in 1975. In 2020, she passed away, and the home was worth $500,000, which became the daughter’s new basis.
The daughter sells the home for $525,000. The taxable capital gain is $25,000, not $475,000. Without the step-up, the gain would have been the sale price minus the original $50,000 cost, a huge tax bill that eats into family wealth.
Assets That Qualify for Step-Up in Basis
Many inherited assets receive a reset on the basis. Here are common examples you might see in an estate or trust administration:
- Real estate
- Stocks and bonds
- Mutual funds
- Art and furnishings
- Collectibles
- Some business interests
Assets held in an irrevocable trust are often not eligible if the asset is excluded from the taxable estate. The rule looks at whether the asset is included in the decedent’s estate for tax purposes, not simply where it is titled.
Assets That Do Not Qualify for Step-Up in Basis
. The items below keep the original owner’s basis or follow their own tax rules on withdrawal.
- Bank accounts
- Cash
- Certificates of deposit
- 401(k)s and other employer-sponsored retirement plans
- IRAs
- Pensions
- Annuities
Retirement accounts are usually taxed as ordinary income when you take distributions. That is a different system from capital gains, so a step-up in basis does not apply to those funds.
Step-Up in Basis and Capital Gains Rates
Short-term gains are profits on assets held for one year or less, taxed at ordinary income rates. Long-term gains apply to assets held for more than one year, taxed at lower rates for most taxpayers.
Inherited assets count as long-term for the heir, even if the person who passed owned the asset for only a short period. That rule, along with the step-up in basis, softens the tax bite when you sell after inheriting.
Rates change each year, and other filing statuses have their own cutoffs. Always check the latest IRS tables or work with a tax professional before filing a return.
Step-Up in Basis in Community Property States vs. Common Law States
Community property is a marital property system used in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In those states, most assets earned or acquired during marriage are community property. The big tax perk: when one spouse dies, both halves of the community property usually receive a full step-up in basis.
Common law states, including Massachusetts, use a different property system. The surviving spouse typically receives a step-up only on the portion that belonged to the deceased spouse. The survivor’s own half of jointly owned property keeps its original basis.
Here is a quick example. A married couple owns a home worth $800,000 with a combined basis of $200,000. If they live in a community property state, the basis for the entire home often resets to $800,000 at the first spouse’s death, which can erase built-in gain for the survivor.
In a common law state, only the decedent’s share steps up. If they owned the home as tenants by the entirety in Massachusetts, half the basis would reset, and the survivor’s half would keep its old basis, which means higher potential gain on a later sale. Some states allow community property trusts to elect community property treatment for tax purposes, including Alaska, Florida, Kentucky, South Dakota, and Tennessee.
Step-Up in Basis and Estate Planning
Assets often grow for decades, and picking the right way to transfer them can make a big difference. The ideas below show common moves people in Massachusetts use.
- Gift mindfully. Lifetime gifts pass a carryover basis, which means the recipient takes your basis and could face higher capital gains later.
- Bequeath highly appreciated assets. Passing assets at death through a will or revocable trust can secure a step-up in basis and cut the tax bill for your beneficiaries.
- Run the numbers. If you are in a lower tax bracket now, selling some appreciated assets today could make sense, while holding others for a future step-up.
- Use the right vehicles. Assets in a revocable trust are usually included in the estate, which helps preserve a step-up. Irrevocable trusts that remove assets from the estate can lose that benefit.
Now, layer in estate taxes. The federal estate tax exemption is very high compared to that of Massachusetts. A plan that balances income taxes, estate taxes, and family goals often delivers better results than a one-asset-at-a-time approach.
Massachusetts does not tax capital gains differently at death, but its estate tax can shape choices about who receives what and when. A step-up in basis can reduce income taxes for heirs, while a sound estate plan can manage the state estate tax. Both pieces work together.
How the Step-Up in Basis Can Help Massachusetts Families
Step-up in basis helps heirs by trimming capital gains tied to growth that happened in a prior generation. Section 1014 of the Internal Revenue Code formalizes this reset and helps prevent double taxation. In real life, that means more of the family’s hard work stays with the family.
Rules shift over time, and small facts can swing the tax result. Work with a tax professional and an estate planning attorney to build a plan that fits your assets and your loved ones. Good planning today can cut stress for your family later.
Plan Your Estate with Casey Lundregan Burns, P.C.
For three generations, Casey Lundregan Burns, P.C., has stood with Massachusetts families in probate, trust, and estate planning matters. We focus on clear guidance and practical steps that fit real life. If you want help shaping an estate plan that keeps taxes in check and reflects your wishes, we would be glad to talk.
Feel free to call us at 978-741-3888 or reach us through our Contact Us page. We welcome your questions, and we are ready to map out the next steps that work for you. A short conversation can bring real peace of mind for you and your family.
The information provided in this blog post does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only.