What Is the Cost Basis of Inherited Assets?

Introduction: Why Cost Basis Matters for Inherited Assets

When you inherit property—whether it is a family home, a portfolio of stocks, or a piece of artwork—your tax obligations hinge on one crucial figure: the cost basis. The cost basis represents the asset’s starting value for tax purposes and determines the size of any gain or loss when you eventually sell. Misunderstanding this figure can lead to overpaying capital-gains tax or triggering an avoidable audit. This article explains how the cost basis of inherited assets is calculated, the rules that apply in different situations, and practical steps heirs can take to document and report it correctly.

What Is Cost Basis?

Cost basis is the original value assigned to an asset for tax reporting. For purchased assets, the basis equals the purchase price plus certain allowable costs like commissions and fees. When property is inherited, however, a different set of rules applies because the heir did not actually buy the asset. The IRS adjusts the basis to approximate current market value at the time of the decedent’s death, which often reduces or eliminates capital gains up to that date.

The Step-Up in Basis Rule

The cornerstone of U.S. inheritance tax law is the step-up in basis. Under Internal Revenue Code § 1014(a), most inherited assets receive a basis equal to their fair market value (FMV) on the decedent’s date of death. If Grandma bought Apple stock decades ago for $10 a share and it’s worth $180 when she passes, your new basis is $180. Should you sell immediately, there is virtually no capital gain to report. This provision prevents heirs from paying tax on appreciation that occurred before they, rather than the decedent, owned the property.

Alternate Valuation Date Option

Estate executors can elect an alternate valuation date six months after the date of death if it lowers the overall estate tax. While this election primarily concerns federal estate tax liability, it cascades down to determine your cost basis as well. If the election is made, the heir’s basis becomes the FMV six months post-death or the sale price if the asset was sold by the estate within that period.

Special Situations That Change the Basis

Community Property States

In community property states—such as California, Texas, and Arizona—surviving spouses often enjoy a double step-up. Both halves of community property receive a new basis, not just the decedent’s share. As a result, a surviving spouse can potentially sell the entire property with minimal or no capital-gains tax.

Property Held in Joint Tenancy

For assets owned as joint tenants with rights of survivorship in non-community-property states, only the decedent’s portion receives a step-up. If a married couple owned a house equally and one spouse dies, half the property gets the adjustment while the other half retains its original basis.

Gifts Received Before Death

If the decedent gave you the asset before death, you may not be eligible for a step-up. Gifted property carries a carry-over basis, meaning you inherit the donor’s original purchase price, not the FMV at the date of gift or death. Timing, therefore, can make a significant tax difference.

Calculating and Documenting Fair Market Value

Because the IRS places the burden of proof on the taxpayer, meticulous documentation is vital. For marketable securities, brokerage statements for the date of death usually suffice. Real estate, collectibles, and closely held business interests often require a professional appraisal. Storing these records with the estate file can save heirs time, money, and stress later, especially if the asset’s value is challenged during an audit.

Reporting the Basis on Your Tax Return

After determining the basis, you report any subsequent sale on Schedule D and Form 8949 of your individual income tax return. The holding period of inherited property is automatically considered long-term, regardless of how soon you sell, which typically qualifies you for lower long-term capital-gains rates. Ensure that the basis you list on Form 8949 matches the information your brokerage transmits to the IRS on Form 1099-B to avoid red flags.

Strategies to Minimize Taxes After Inheritance

Hold Appreciated Assets Until Death

Families often retain highly appreciated assets within older generations specifically to obtain the step-up. Selling just before death can create a large capital-gains bill that the estate or heirs must pay.

Harvest Tax Losses

If the inherited asset declines in value after the decedent’s death but before you sell, those losses can offset gains elsewhere in your portfolio. Understanding your stepped-up basis lets you identify and harvest legitimate tax losses.

Use Charitable Contributions

Donating appreciated inherited property directly to a qualified charity allows you to deduct the FMV without realizing capital gains. This strategy pairs well with assets that have grown significantly after inheritance.

Common Mistakes to Avoid

• Failing to obtain or keep an appraisal for unique assets.
• Using the decedent’s original purchase price instead of the stepped-up basis.
• Ignoring state-level inheritance or estate tax rules, which may differ from federal law.
• Assuming gifted property will receive a step-up at donor’s death.

Key Takeaways

1. Most inherited assets receive a step-up in basis to FMV at the decedent’s death, sharply reducing capital-gains tax when sold.
2. Special rules apply in community property states, for jointly owned assets, and for gifts.
3. Document FMV with reliable records such as brokerage statements and professional appraisals.
4. Report sales on Schedule D and Form 8949, using the stepped-up basis to calculate gain or loss.
5. Strategic timing and planning—such as holding highly appreciated property until death—can maximize tax benefits for heirs.

Conclusion

Understanding the cost basis of inherited assets is essential for anyone who anticipates receiving or passing on wealth. By leveraging the step-up in basis and following IRS documentation rules, you can significantly lower capital-gains taxes and ensure compliance. Consult with tax professionals and appraisers early to safeguard your financial legacy and avoid costly mistakes.