Step-Up in Basis After Death: What Financial Advisors Need to Calculate

A client bought 10,000 shares of a blue-chip stock in 1987 at $12 per share. At their death in 2026, the stock is trading at $185. The original cost basis is $120,000. The current market value is $1,850,000. That is $1,730,000 in unrealized capital gains that, under normal circumstances, would trigger a six-figure federal tax bill if sold.

Under IRC Section 1014, those unrealized gains disappear. The heir's new cost basis resets to the fair market value on the date of death — $1,850,000. If they sell the next day at $1,850,000, their taxable gain is zero.

This is the step-up in basis, and it is one of the most powerful tax provisions in the Internal Revenue Code. For financial advisors managing an estate transition, calculating it correctly is both a fiduciary obligation and a significant value-add for the inheriting family.

How IRC Section 1014 Works

Section 1014(a) generally provides that the basis of eligible property acquired from a decedent is its fair market value at the date of death. Statutory exceptions include income in respect of a decedent. Eligible property commonly includes:

• Stocks, bonds, and mutual funds held in taxable accounts
• Real estate
• Business interests
• Other eligible capital assets passing from the decedent

For eligible property, the basis adjustment generally removes the decedent's pre-death appreciation from the heir's later capital-gain calculation. It does not matter when the asset was purchased, what the original price was, or how much appreciation occurred.

Retirement accounts — IRAs, 401(k)s, and 403(b)s — generally do not receive a Section 1014 basis step-up. Distributions from inherited pre-tax traditional accounts are generally taxed as ordinary income; qualified inherited Roth distributions are generally tax-free, and after-tax basis in a traditional IRA is not taxable.

Calculating Inherited Stock Basis

For each individual holding, the calculation requires:

1. Determine the date-of-death FMV. For publicly traded securities, this is the mean of the high and low trading prices on the date of death. If the death occurred on a non-trading day, use the weighted average of the nearest trading days.

2. Identify the ownership structure. In sole ownership, the entire position steps up. In joint ownership, the step-up depends on the titling and the state.

3. Apply the step-up. The heir's new basis equals the FMV determined in step 1, multiplied by the ownership percentage that steps up.

4. Document everything. The date-of-death valuation report becomes the permanent record for calculating gains and losses on any future sale. If the heir sells ten years later, this report is what the CPA will reference.

For a diversified portfolio with dozens of positions, each holding gets its own line-item calculation. Positions with losses at the date of death also step down to FMV, so the pre-death unrealized loss generally does not carry over as a deductible loss to the heir.

Common Law vs. Community Property: A Real Dollar Difference

The biggest variable in the step-up calculation is whether the decedent lived in a common law or community property state.

Common law states (41 states + D.C.): Only the decedent's ownership share receives the step-up. For a JTWROS account between spouses, that means 50% of each holding steps up to FMV. The surviving spouse's half retains its original basis.

Example: A couple purchased a portfolio for $200,000. At the first spouse's death, it is worth $1,000,000. In a common law state, the surviving spouse's new basis is $600,000 — their original $100,000 plus the decedent's $500,000 stepped-up half. Selling immediately triggers $400,000 in capital gains.

Community property states (AZ, CA, ID, LA, NV, NM, TX, WA, WI): Under Section 1014(b)(6), both the decedent's and the surviving spouse's halves of qualifying community property receive a full basis adjustment.

Same example: In a community property state, the surviving spouse's new basis is the full $1,000,000. Selling immediately produces no gain from appreciation before death.

That is a $400,000 difference in taxable gain from a single calculation choice. For high-net-worth clients with concentrated, highly appreciated positions, the community property double step-up can save hundreds of thousands of dollars in taxes.

Losses Step Down Too

The step-up works in both directions. If an asset has declined in value below the decedent's original purchase price, the heir's basis steps down to the lower date-of-death FMV.

If the decedent bought stock at $50 per share and it was trading at $30 on the date of death, the heir's basis is $30. The $20 per share pre-death unrealized loss generally is not deductible by the estate or the heir after the basis adjustment.

This can make a pre-death sale worth discussing with the client's tax adviser; whether it helps depends on the client's overall tax situation.

Mistakes That Cost Heirs Money

Failing to document the step-up. If the heir sells inherited stock years later and cannot substantiate their basis, they may face an IRS challenge or have to report a larger gain. The valuation report created at the time of death supports the basis calculation.

Applying the wrong ownership percentage. A 50% step-up applied to community property leaves tax savings on the table. A 100% step-up applied to common law JTWROS overstates the basis and creates future underreporting risk.

Forgetting about cost-basis adjustments for reinvested dividends. If the decedent was reinvesting dividends in a taxable account, those reinvested shares have their own basis (the price at each reinvestment date). At death, all shares — including reinvested dividend shares — step up to date-of-death FMV. But if the advisor only steps up the original lot and misses the reinvested shares, the calculation will be wrong.

The step-up in basis is one of the most consequential calculations in the entire estate transition. Getting it right requires a systematic approach — position by position, account by account, with clear documentation. The Financial Advisor's Deceased Client Guide includes a valuation and step-up worksheet designed to walk through this process without missing a holding.