Inheritance, Taxes, and a Nice Surprise

The Unexpected Relief of Stepped-Up Basis, Explained

Takeaways:

• Inherited assets come with their own tax rules—understanding them can protect your peace of mind.

• Stepped-up cost basis can significantly reduce capital gains taxes.

• Sometimes the most comforting part of a legacy is clarity, not cash.

When Inheritance Brings Anxiety Instead of Peace of Mind

Not long ago, I listened as someone patiently explained “cost basis” to her sibling after the death of a parent. They were trying to make sense of brokerage accounts and potential taxes.

It was surprisingly touching—an exchange between grief and logic, between honoring someone’s legacy and understanding how to responsibly carry it forward.

Very often, when people consider inheritances, they think of money coming into their lives. When they think of money coming into their lives, they are excited at first. That excitement subsides and then they panic at the tax implications. But, when they understand terms like cost basis, they may calm down.

Many people are unacquainted with terms “cost basis” and “stepped-up cost basis.”

Hang in there for a moment and I’ll explain why stepped-up cost basis should help you relax.

Cost Basis and Why It Matters

Cost basis means “cost” or what you paid for something. In real estate, the cost basis of a property is the price you paid for the property originally plus the cost of major improvements. In the stock market, the cost basis of shares of a company is the price you paid for shares and transaction fees (if any).

When you sell real estate or stock or other assets, you may pay taxes on any gains. There are however many ways that ordinary people avoid immediate taxes on these gains.

For example, if the real estate is your primary residence (where you live and have lived for 3 of the last 5 years), then you’ll receive an exemption for taxes for up to $250,000 in gains ($500,000 if married, filing jointly). As another example, if you sell stock held inside of an IRA, Roth IRA, or other tax-advantaged account, then you will not owe taxes associated with the gain generated from a sale. (You may however pay taxes on withdrawals from IRAs).

What Changes When Someone Passes Away

This cost set-up shifts if you’re fortunate to receive an inheritance. In this scenario – in which you receive assets, like real estate or stocks, a “stepped-up” cost basis applies. Instead of the plain old cost basis associated with the purchase price of the assets, the new cost basis is the fair market value of the assets on the date of your beloved’s death (also called date of death valuation).

Very often, this stepped-up cost basis is higher than the original cost basis, especially if the assets were purchased years ago and have increased significantly in value. So, when you sell the asset, you’ll owe less in taxes with the stepped-up cost basis compared to what you might owe if you retained the original cost basis.

A Practical Example of the Value of the New, Stepped-up Cost Basis

As an example, let’s say your mom bought 100 shares of IBM for $5 in 1970 through a direct purchase program. Her cost basis is $500. If she sold the shares for $200 for a total of $20,000 in 2024, her capital gain is $19,500 ($20,000-$500).

However, if she held onto those shares and bequeathed them to you and you sold the shares, then the capital gains calculation changes. Let’s say the value of the shares on the day of her death was $215 for a stepped-up basis of $21,500 and you sold the shares at $225 for a total of $22,500. Your capital gain is $1,000 and you’ll pay taxes on that amount, instead of – whew! – $22,000.

Less Taxing, More Peace of Mind

There are so many things to be concerned with following a loved one’s death. Hopefully, this tax rule related to cost basis will ease the burden and allow you to appreciate your loved one and their gifts to you.