How the IRC § 1014 Basis Adjustment at Death Operates An Overview of the “Step-Up in Basis” Rule

​IntroductionInternal Revenue Code (IRC) § 1014 establishes the rules for basis adjustment of property acquired from a decedent. Commonly referred to as the “step-up in basis” at death, this provision is a cornerstone of estate and income tax planning in the United States. Understanding how it operates is crucial for heirs, executors, and tax advisors alike.
What Is Basis?In tax terminology, “basis” generally refers to the amount invested in a property for tax purposes. The basis is typically the cost to acquire an asset, including purchase price and certain transaction costs. Basis is important because it determines the amount of capital gain or loss when the property is sold.
The General Rule of IRC § 1014IRC § 1014 provides that the basis of property acquired from a decedent is generally adjusted to its fair market value (FMV) as of the date of the decedent’s death. This adjustment is often called a “step-up” (or, less commonly, a “step-down” if the value has decreased).

• If the FMV at death is greater than the decedent’s original basis, the basis “steps up.”
• If the FMV at death is less than the decedent’s original basis, the basis “steps down.”

How the Step-Up WorksWhen a person dies owning appreciated property (e.g., real estate, stocks, a business), the heir or beneficiary receives a new basis equal to the property’s FMV at the date of death (or the alternate valuation date, if elected by the estate). For example:

• If the decedent bought stock for $10,000 and it is worth $100,000 at death, the heir’s basis becomes $100,000.
• If sold immediately for $100,000, there would be no capital gain and therefore no capital gains tax.

Who Receives the Step-Up?The step-up applies to property “acquired from a decedent,” which generally includes:

• Property inherited outright through a will or intestacy
• Property received by a surviving spouse through joint tenancy or community property
• Certain property transferred to a trust

However, property that passes as a lifetime gift (rather than at death) is not eligible for a step-up and instead carries over the donor’s basis.
Exceptions to the Step-Up RuleThere are certain exceptions and limitations:

• Property with income in respect of a decedent (IRD): Items like retirement accounts and unpaid compensation are not eligible for a step-up in basis.
• Non-U.S. situs property: Different rules may apply for non-U.S. assets.
• Generation-skipping transfers: Additional rules may apply for GST trusts and transfers.
• Property gifted within one year of death: No step-up if the property returns to the original donor.

Alternate Valuation DateThe estate’s executor may elect an alternate valuation date (six months after death) if it reduces the value of the gross estate and the estate tax due. In this case, the property’s basis is its FMV on the alternate valuation date.
Planning ImplicationsThe basis step-up at death can significantly reduce capital gains tax for heirs, making it favorable to hold appreciated assets until death rather than gifting them during life. This principle often informs estate planning strategies.
ConclusionIRC § 1014’s basis adjustment at death is a pivotal concept in U.S. tax law. It allows heirs to receive property with a new basis at the asset's date-of-death value. This often eliminates capital gains tax on appreciation that occurred during the decedent’s lifetime, providing a valuable tax benefit and shaping strategies for wealth transfer.