Stepped-Up Basis Explained: How NC Heirs Save Thousands on Capital Gains Tax

Stepped-Up Basis Fundamentals: How It Works and Why It Matters

If you’re inheriting property from a parent or family member, one of the most valuable tax benefits available to you is probably something you’ve never heard of: the stepped-up basis.

The stepped-up basis is one of the largest tax breaks in the entire US tax code. It works like this: when you inherit property, your cost basis (the value used to calculate capital gains tax) automatically resets to the fair market value on the date the person died. This means decades of accumulated appreciation can pass to you tax-free.

Let’s say your parent bought a house in 1990 for $80,000. They improved it over the years and it was worth $350,000 when they died. Under stepped-up basis, your new cost basis becomes $350,000, not $80,000. If you sell the house immediately for $350,000, you owe zero capital gains tax. The entire $270,000 of appreciation that happened during your parent’s lifetime is permanently forgiven.

This benefit is automatic for most inherited property, but understanding how it works and properly documenting it protects you from costly mistakes and IRS challenges.

Cost Basis and Capital Gains: Foundation Concepts

Before we dive into stepped-up basis, you need to understand cost basis and capital gains.

Your cost basis in a property is typically the price you paid for it, plus improvements you made, minus any depreciation. It’s the starting number used to calculate how much profit you made when you sell.

A capital gain is the difference between your selling price and your cost basis. If you buy stock for $10,000 and sell it for $15,000, your capital gain is $5,000.

Capital gains tax is the tax you pay on that gain. Long-term capital gains (assets held more than one year) are taxed at favorable rates: 0%, 15%, or 20%, depending on your income. These rates are much lower than ordinary income tax rates.

Here’s a concrete example: You inherit your parent’s investment portfolio. The stocks in that portfolio were purchased for $50,000 (your parent’s cost basis). When your parent died, those stocks were worth $150,000. Normally, if you sold the stocks, you’d inherit your parent’s $50,000 basis, sell at $150,000, and owe capital gains tax on the $100,000 gain. At the 15% rate, that’s $15,000 in tax.

But stepped-up basis changes this entirely.

Stepped-Up Basis Benefit: Reset to Fair Market Value at Death

Here’s what stepped-up basis actually does: when you inherit property, your new cost basis automatically steps up to the fair market value on the date the person died.

In the example above, stepped-up basis means your cost basis becomes $150,000, not $50,000. If you sell the stocks immediately for $150,000, your capital gain is zero. You owe zero taxes. The entire $100,000 gain is forgiven.

This is not a tax deferral. It’s not something you have to elect. It’s automatic. The appreciation that occurred during your parent’s or relative’s lifetime is permanently wiped off the books from a tax perspective.

The magnitude of this benefit depends on how long the asset was held. Long-held real estate and investments see the biggest benefits. Farmland purchased in 1970 and appreciated to $650,000 by 2026 creates massive stepped-up basis savings. A home purchased in 1990 for $80,000 and worth $350,000 at death: the $270,000 appreciation is permanently forgiven.

Who Gets Stepped-Up Basis?

Every heir inheriting property gets stepped-up basis automatically. It doesn’t matter whether you’re a citizen, a resident, or an out-of-state heir. It doesn’t matter how distant your relationship to the deceased. If you inherit property, you get stepped-up basis.

Real property (homes, land, rental properties, mineral rights) gets stepped-up basis. Personal property like stocks, bonds, vehicles, jewelry, and collectibles all get stepped-up basis. Joint property with right of survivorship gets stepped-up basis for the full value when the first spouse dies.

There are important exceptions. Property with a named beneficiary (like life insurance) doesn’t get stepped-up basis because it doesn’t pass through the estate. Retirement accounts like IRAs and 401(k)s don’t get stepped-up basis either. More on that later.

Why This Matters Financially

Stepped-up basis is typically a more valuable benefit than federal estate tax exemptions for most families. Consider this: federal estate tax only applies to estates above $13.61 million (2024), and North Carolina has no state estate tax. So if your parent’s estate is under $13.61 million, you owe zero federal estate tax.

But stepped-up basis applies to every estate, no matter how large or small. A $500,000 estate with no estate tax can still save tens of thousands in capital gains tax through stepped-up basis.

For high-net-worth families, the numbers are striking. An estate with a $1 million appreciated home and $500,000 in appreciated investment accounts saves roughly $150,000 to $225,000 in capital gains tax through stepped-up basis. That savings dwarfs most estate planning strategies.

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Date of Death Valuation: The Critical Appraisal Date

Stepped-up basis is valuable only if you can prove the fair market value of the assets on the date of death. This is where documentation becomes critical.

Fair Market Value on Date of Death

Stepped-up basis equals fair market value (FMV) on the exact date of death. Not before, not after. The IRS defines fair market value as the price at which property would sell between a willing buyer and a willing seller, neither being under pressure to buy or sell.

For real property, FMV is determined by an appraisal or comparable sales analysis. For publicly traded securities, FMV is simply the closing market price on that date. For non-traded securities, collectibles, or other assets, an appraisal may be necessary.

The executor of the estate is responsible for determining and documenting fair market value. This is not optional, especially if the asset is later sold and a capital gains tax return is filed.

Obtaining Date-of-Death Appraisals

If the total estate value exceeds $1 million, the IRS requires a formal appraisal for federal estate tax filing purposes. Even if the estate doesn’t reach $1 million and no federal estate tax is owed, heirs should still obtain appraisals to substantiate stepped-up basis. This documentation protects you against an IRS audit later.

A qualified appraiser must be licensed and independent. They can’t be related to the deceased or the heirs. The appraisal typically costs $300 to $1,000 per property, depending on complexity. For a residential home, expect $500 to $800.

The appraisal date should be the date of death, or within 30 days. The appraiser provides a written report documenting their methodology and the concluded fair market value. Keep this report for at least seven years (the standard IRS audit period).

Alternative Valuation Date: 6-Month Option

In rare situations, the executor can elect an alternate valuation date six months after death. This is only useful if the estate is subject to federal estate tax AND the assets declined in value during those six months. Using the alternate date can reduce estate tax if assets lost value.

Here’s the catch: if you elect the alternate date, ALL assets must be revalued to six months after death. You can’t pick and choose which assets use which date.

In North Carolina, the alternate valuation date is rarely relevant. The federal exemption is so high ($13.61 million in 2024) that most estates don’t owe federal tax. And if they don’t owe tax, there’s no benefit to using the alternate date.

Securities and Stock Portfolio Valuation

For publicly traded stock, the valuation is straightforward: look up the closing price on the date of death. If your parent held multiple positions, you’ll document the closing price for each stock. Mutual funds are valued at their Net Asset Value (NAV) on that date. Bonds are valued at closing price.

For non-traded securities (privately held business interests, startup shares), you’ll need an appraisal using income-based or comparable-company methods. This is more complex and typically requires a business valuation professional.

All of this information is documented and provided to the heirs so it can be used when they eventually sell the assets.

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Real Estate Stepped-Up Basis: NC Home Sale Examples

The real power of stepped-up basis becomes clear when you work through actual North Carolina home scenarios.

Example 1: Appreciated Home (Most Common Scenario)

Let’s say your parent purchased a home in Wake County in 1995 for $120,000. Over the years, they added a kitchen remodel for $30,000 and replaced the roof for $15,000. Your parent’s cost basis in the home was $165,000.

When your parent died, the home was appraised at $450,000 (fair market value).

You inherit the home. Your stepped-up basis is automatically $450,000, not $165,000.

Six months later, you decide to sell. The sale price is $455,000.

Your capital gain is $455,000 (sale price) minus $450,000 (stepped-up basis) = $5,000.

At the 15% long-term capital gains rate, your tax is $750.

Now, let’s compare: if you had inherited your parent’s original $165,000 basis, your capital gain would have been $455,000 minus $165,000 = $290,000. Your tax would have been $43,500.

Stepped-up basis saved you $42,750 on this single home.

Example 2: Long-Term Hold (Decades of Appreciation)

Your parent purchased farmland in rural Iredell County in 1970 for $50,000. Over 50-plus years, they invested in improvements: an irrigation system for $25,000, an equipment shed for $10,000. Your parent’s adjusted cost basis was $85,000.

By the time your parent passed, the land was appraised at $650,000 (the appreciation reflects decades of agricultural demand growth in that area).

You inherit the land with a stepped-up basis of $650,000.

Two years later, you decide to sell. The land has appreciated another $50,000 and sells for $700,000.

Your capital gain is $700,000 minus $650,000 = $50,000.

Your long-term capital gains tax at 15% is $7,500.

If you had inherited your parent’s original $85,000 basis, your capital gain would have been $700,000 minus $85,000 = $615,000. Your tax would have been roughly $92,250.

Stepped-up basis saved you $84,750 on the farmland sale.

Example 3: Depressed Market (Stepped-Up Basis Still Applies)

What if the market moved down? Let’s say your parent bought a condo in Charlotte in 2006 (peak real estate market) for $250,000. By the time they died in 2024, the property had declined to $180,000 (market correction and property aging).

You inherit the condo. Your stepped-up basis is $180,000, reflecting the current fair market value.

One year later, you sell for $190,000.

Your capital gain is $190,000 minus $180,000 = $10,000.

Your capital gains tax at 15% is $1,500.

Note: If your parent had sold during the market decline (before death), they would have realized a $70,000 loss. The bad news is that capital losses can’t be used to offset future gains (there’s a limit). You would have gotten no tax benefit from that loss. But because you inherited the property, you inherit it at the stepped-up value of $180,000, avoiding the loss entirely. Stepped-up basis applies even in down markets.

Documentation for Real Estate Stepped-Up Basis

For any of these home sales to work correctly, you need documentation.

Get a professional appraisal on or near the date of death. The appraiser’s report becomes your evidence of fair market value. Provide the appraisal to your CPA and to the executor.

If the estate requires a federal estate tax return (Form 706), the appraisal is filed with that return. If no federal estate tax is required, keep the appraisal in your files.

When you eventually sell the property, give the appraisal to your CPA. The CPA will use the appraised value as your cost basis on your capital gains tax return (Form 8949). The CPA’s workpapers will document the appraisal and the stepped-up basis calculation.

Without this documentation, if the IRS ever audits your capital gains return, you won’t have proof of your cost basis. The IRS could challenge your calculation and demand back taxes plus interest.

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Assets That Get Stepped-Up Basis vs. Those That Don’t

Not all inherited assets get stepped-up basis. Understanding which assets do and which don’t is crucial for tax planning.

Full Stepped-Up Basis (Yes, These Get It)

Real property gets stepped-up basis: homes, land, rental properties, mineral rights, timberland.

Stocks and bonds in regular (non-retirement) brokerage accounts get stepped-up basis. So do mutual funds, exchange-traded funds, and similar investments.

Collectibles get stepped-up basis: art, antiques, classic vehicles, jewelry, coin collections.

Business interests get stepped-up basis: ownership stakes in partnerships, LLC membership interests, shares of closely held corporations.

Notes and accounts receivable get stepped-up basis: loans your parent made to others, outstanding rent, unpaid wages.

Cryptocurrency and digital assets get stepped-up basis.

The key rule: any property you inherit at the date of death gets stepped-up basis, unless it’s a retirement account or has a named beneficiary outside the will.

NO Stepped-Up Basis (These Are Excluded)

Here’s where heirs often make costly mistakes.

Traditional IRAs do not get stepped-up basis. When you inherit a traditional IRA, you inherit the account with the original cost basis untouched. All future distributions are taxed as ordinary income. For a $400,000 inherited traditional IRA, you might pay $100,000 or more in federal and state income tax over 10 years of distributions.

401(k)s, 403(b)s, and other workplace retirement plans don’t get stepped-up basis either. Same problem: distributions are taxed as ordinary income.

Roth IRAs don’t get stepped-up basis because they don’t need it. Roth accounts grow tax-free, and your distributions are tax-free. The benefit is already built in.

Annuities with a named beneficiary pass directly to the beneficiary, outside the estate, and don’t receive stepped-up basis treatment.

Life insurance proceeds with a named beneficiary go directly to that beneficiary and aren’t stepped-up. However, life insurance proceeds aren’t income taxable anyway, so this is less of an issue.

Payable-on-death (POD) bank accounts and transfer-on-death (TOD) securities accounts pass to the named beneficiary outside the estate. They don’t get stepped-up basis for income tax purposes, but practically speaking, the account balance is reported as it was, and no capital gains calculation typically occurs.

US Savings Bonds with a named beneficiary pass to that named person without stepped-up basis.

Key Distinction: Retirement Accounts vs. Inherited Property

This is critical: retirement accounts and inherited property have completely different tax treatment.

Inherited property with stepped-up basis: You avoid capital gains tax on appreciation during the original owner’s lifetime. When you eventually sell the property, you calculate capital gains only on appreciation after the date of death. Capital gains tax rates (0%, 15%, or 20%) apply.

Inherited retirement accounts: No stepped-up basis. Instead, you owe ordinary income tax on distributions. Ordinary income tax rates (10% to 37%) apply, which are much higher than capital gains rates.

A $400,000 inherited portfolio of stocks gets stepped-up basis. If you sell it immediately after inheriting, you owe zero capital gains tax.

A $400,000 inherited IRA gets no stepped-up basis. Over 10 years of distributions, you might owe $100,000 or more in taxes.

The executor and your CPA must correctly categorize each asset to avoid mistakes.

Joint Property and Stepped-Up Basis Mechanics

When spouses own property jointly with right of survivorship, stepped-up basis works slightly differently.

When one spouse dies, the property automatically passes to the surviving spouse (no probate needed). The surviving spouse receives a 50% stepped-up basis on the inherited portion. The other 50%, which the surviving spouse already owned, retains the original cost basis.

Here’s an example: A married couple owns a $500,000 home jointly, with right of survivorship. One spouse’s name, the other spouse’s name, both equally. One spouse dies. The surviving spouse now owns 100% of the home.

For the inherited 50% ($250,000 value), the surviving spouse gets stepped-up basis. For their original 50%, the original basis stands.

This distinction matters if the surviving spouse later sells. The CPA must allocate the sales price between the two portions and apply the appropriate basis to each.

North Carolina is a separate property state, not a community property state. This means the stepped-up basis mechanics are more restrictive in NC than in community property states. In community property states, both spouses’ shares sometimes get full stepped-up basis. In NC (separate property), each spouse’s share retains its own basis treatment.

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Coordination with NC Property Taxes and County Revaluation

Here’s something many heirs don’t realize: stepped-up basis (for federal income tax purposes) is separate from county property tax assessment.

Property Tax Revaluation Schedule and Stepped-Up Basis

North Carolina counties revalue property for property tax purposes every 4 to 8 years. When property changes ownership due to a death, the county often triggers a reassessment.

The county will assess the property at a new fair market value (for property tax calculation). This assessment is separate from stepped-up basis.

Stepped-up basis is used for federal income tax purposes (capital gains calculation). The property tax assessment is for state and local property tax. They can be different.

Don’t confuse the two. The stepped-up basis value might be $350,000. The county’s assessed value (for property tax) might be $340,000. Both are correct for their respective purposes.

Understand which valuation applies where: stepped-up basis for capital gains; county assessment for property taxes.

Homestead Exemption Continuation

If the deceased was receiving a homestead exemption on their primary residence (a reduction in property tax value), that exemption can continue to the heir if the heir occupies the home as their primary residence.

The executor files a homestead exemption continuance form with the county. The exemption then reduces the heir’s property tax value going forward.

The heir benefits from both: lower property taxes (homestead exemption) and eliminated capital gains tax (stepped-up basis). These are two separate tax benefits working in parallel.

Agricultural Property and Present-Use Value Coordination

Agricultural property in North Carolina can qualify for present-use value tax deferral under NCGS 105-277.2. This provision values the property based on its agricultural use, not its potential market value.

Stepped-up basis applies to the date-of-death fair market value.

Present-use value might be significantly lower than fair market value.

The executor should document both: fair market value (for stepped-up basis) and present-use value (for property tax deferral). If the heir continues farming, present-use deferral applies. If the heir sells the land later, a rollback tax may apply (the county will recalculate property taxes for prior years at fair market value).

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Documentation and IRS Audit Protection

The benefit of stepped-up basis only exists if you can prove it to the IRS if questioned.

IRS Documentation Requirements for Stepped-Up Basis

Here’s what you must have if audited:

An appraisal report for real property, prepared by a licensed appraiser documenting the date-of-death fair market value.

Brokerage statements showing closing prices for publicly traded securities on the date of death.

County tax assessor records that can corroborate date-of-death values.

A certified copy of the death certificate proving the valuation date.

Deed or title documentation proving ownership at death.

All of these documents should be organized and retained for at least seven years (the standard IRS audit period, though assessments for significant understatements can go longer).

Audit Defense: What Heirs Must Produce

If the IRS questions your capital gains calculation when you sell inherited property, you must produce evidence of your cost basis.

The date-of-death appraisal is your strongest evidence. A professional appraisal conducted at or near the date of death and supporting FMV is difficult for the IRS to overturn.

Your CPA’s tax return and workpapers showing the stepped-up basis calculation.

Any correspondence with the appraiser documenting methodology.

Heirs who don’t document stepped-up basis and later get audited face challenges from the IRS and potential assessments of back taxes plus interest. Don’t skip the documentation step.

Executor’s Role in Documenting Stepped-Up Basis

This responsibility falls on the executor.

The executor should obtain appraisals for all significant assets, especially real property and valuable personal property.

The executor provides copies to heirs and to the CPA (before tax returns are filed).

The executor files appraisals with the estate tax return if one is required.

The executor notes stepped-up basis values in the estate accounting and inventory.

The executor provides heirs with a written summary of each asset’s stepped-up basis value. This summary becomes the heirs’ roadmap for capital gains calculations later.

Afterpath’s platform automates this process. Your asset valuation tracker ensures all assets are documented and appraised before the estate closes. You won’t forget an asset or overlook appraisal needs.

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Planning Implications and Preservation of Stepped-Up Basis

Understanding stepped-up basis has planning implications that matter before someone dies.

Lifetime Gifts vs. Inherited Property

Here’s a key planning principle: lifetime gifts do NOT get stepped-up basis. If your parent gives you appreciated property while they’re alive, your cost basis is your parent’s original cost basis, not the value on the date of the gift.

Inherited property does get stepped-up basis to the date-of-death value.

For appreciated assets (property that’s likely to increase in value), the better strategy is to hold and inherit, not to gift.

Imagine a parent considering gifting appreciated stock to a child. The stock was purchased for $50,000 and is now worth $200,000. The parent expects it to appreciate to $400,000 over the next 10 years.

If the parent gifts the stock now, the child’s basis is $50,000. In 10 years, when the child sells at $400,000, the capital gain is $350,000. The capital gains tax is roughly $52,500 (at 15%).

If the parent holds the stock and passes it to the child at death, the child’s basis steps up. If the child inherits when the stock is worth $350,000, the stepped-up basis is $350,000. If the child then sells, the capital gain is minimal.

Inheritance planning is superior to lifetime gifting for appreciated assets.

Revocable Trusts and Stepped-Up Basis

Many people worry that using a revocable trust (a common estate planning tool) somehow eliminates stepped-up basis. This is false.

Property in a revocable trust at the person’s death still receives stepped-up basis. The trust is “transparent” for tax purposes. The step-up happens the same way it would outside a trust.

The trustee’s responsibility is the same as an executor’s: obtain appraisals and document stepped-up basis.

Don’t let misconceptions about trusts and stepped-up basis scare you away from a trust if your attorney recommends one for other reasons (probate avoidance, privacy, incapacity planning).

Irrevocable Trusts and Stepped-Up Basis Loss

Here’s where real caution is needed: irrevocable trusts.

If you place appreciated property into an irrevocable trust during your lifetime, that property does NOT receive stepped-up basis. It passes to beneficiaries at the original cost basis.

This is a major tax disadvantage of irrevocable trusts for appreciated assets.

Irrevocable trusts are appropriate for other reasons (asset protection, control over distributions), but they create a stepped-up basis loss. If you hold appreciated assets and are considering an irrevocable trust, understand this tax cost before proceeding.

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FAQ: Stepped-Up Basis

Q: What if the property is worth less at death than when purchased? Does stepped-up basis still apply?

Yes. Stepped-up basis is reset to fair market value on the date of death, whether that’s higher or lower than the original purchase price. If a property was purchased for $250,000 and is worth $180,000 at death, the stepped-up basis is $180,000. You get a fresh start at the current value.

Q: Do I have to do anything to claim stepped-up basis, or is it automatic?

It’s automatic. You don’t file anything special to “claim” it. But you must document it through appraisals and provide the documentation to your CPA when you eventually sell the asset.

Q: Will Afterpath help me document stepped-up basis for assets I’m inheriting?

Yes. Afterpath’s valuation tracker ensures all inherited assets are appraised at date of death. You’ll have organized appraisal documentation ready for your CPA, protecting you against IRS questions later.

Q: What’s the difference between stepped-up basis and a step-down?

Stepped-up basis is when inherited property is valued at the date-of-death fair market value (usually higher than purchase price). A step-down is rare but can occur if property declined in value. The term is still “stepped-up basis” even if the new value is lower; the mechanism is the same.

Q: If I inherit property and immediately sell it, do I owe any capital gains tax?

Not if the sale price equals the date-of-death appraised value. Capital gain = sale price minus cost basis. If your cost basis (stepped-up basis) equals the sale price, your gain is zero and you owe zero tax.

Q: Should I get an appraisal even if the estate is below the federal exemption and no estate tax is owed?

Yes. Even without federal estate tax, appraisals protect you against future IRS audit. If you ever sell the inherited property and the IRS questions your basis, the appraisal proves your stepped-up basis value. It’s inexpensive insurance.

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The Value of Professional Guidance

Stepped-up basis is powerful, but it requires careful attention to documentation and timing. The executor needs to coordinate appraisals, the heirs need to understand their basis for later sales, and the CPA needs the right documentation to file accurate tax returns.

Missing appraisals or forgetting to document basis can cost heirs tens of thousands of dollars in unnecessary taxes down the road.

If you’re administering an estate, Afterpath can guide you through the valuation process step by step. If you’re an heir inheriting property, work with a CPA to understand your stepped-up basis before you sell. The small investment in documentation now prevents regrettable tax bills later.

For NC families, stepped-up basis is often the single most valuable tax benefit in the entire estate. Make sure it’s properly documented and preserved.