A Lifetime of Gain, Erased in a Single Day
There is a provision in the code that quietly does more for ordinary families than most of the strategies people spend years on. Assets passing at death generally take a new basis equal to their market value on that date. Forty years of unrealised appreciation, never taxed and now never taxable. Understanding which assets get it — and which conspicuously do not — changes what you should spend and what you should leave.
- The answer:: Inherited assets take a basis equal to their date-of-death value. Sell immediately and there is essentially no gain to report.
- The holding period is automatic:: Inherited property is treated as long-term regardless of how briefly the heir has held it, so the favourable rate applies from day one.
- Retirement accounts get nothing:: A traditional IRA or 401(k) has no basis to step up. Every dollar is ordinary income to the beneficiary as it comes out.
- It can step down too:: An asset worth less at death than it cost takes the lower value, and the loss is lost — a reason to consider realising losses during life rather than holding them.
Where the AI summary above gets this wrong
"Your heirs will have to pay capital gains tax on the investments they inherit from you."
That's surface-true. Here's what it misses:
- On the gain accumulated during your life, generally not — The basis resets to date-of-death value, so appreciation over the owner's lifetime is never taxed as capital gain. An heir who sells shortly after inheriting typically reports little or no gain. Only appreciation after the date of death is theirs to be taxed on.
- Retirement accounts are the glaring exception — A traditional IRA or 401(k) carries no step-up. The beneficiary pays ordinary income tax on every dollar withdrawn — at ordinary rates, not capital gains rates. Treating all inherited assets alike is the most expensive version of this misunderstanding.
- Giving during life forfeits it — A gift carries your basis to the recipient; an inheritance resets it. Gifting the most appreciated holding in your portfolio hands over the embedded gain that death would have erased — which reverses the usual instinct about generosity.
01 How the reset works
Property acquired from a decedent generally takes a basis equal to its fair market value on the date of death. Whatever the original owner paid becomes irrelevant, and the gain that accumulated during their life simply ceases to exist for tax purposes.
Shares bought for $120,000 and worth $600,000 at death pass to an heir with a basis of $600,000. Sold the following week for $605,000, the taxable gain is $5,000 rather than $485,000. The difference is not deferred or sheltered — it is gone.
Two details make it more useful than it first appears. Inherited property is automatically treated as long-term regardless of how briefly the heir has held it, so the lower long-term rate applies to any post-death appreciation from the first day. And in community property states, both halves of community property can receive the adjustment when the first spouse dies — not merely the deceased's half.
Shows: the gain that disappears when an heir takes the asset at its date-of-death value instead of the original cost, and the tax that gain would have carried. Ignores: state tax, any estate tax on very large estates, and depreciation recapture on a rented property.
Source: Publication 551, Basis of Assets
02 What does not get it
The exception matters more than the rule for most retirement planning. Traditional IRAs, 401(k)s and other pre-tax retirement accounts receive no step-up. There is no basis in them to adjust — the money was never taxed — so a beneficiary pays ordinary income tax on every dollar they withdraw.
That is a materially worse outcome than an inherited brokerage account of the same size. One passes with its gain erased and is taxed only on future growth; the other is fully taxable at ordinary rates, compressed into the ten-year window most beneficiaries face under the distribution rules.
Annuities are similar: the untaxed gain inside a non-qualified annuity passes as income in respect of a decedent and is taxed to the beneficiary. Roth accounts sit in a better position — no step-up either, but nothing needing one, since qualified withdrawals are already tax-free.
Source: Publication 559, Survivors, Executors, and Administrators
03 What it implies for spending order
Once you know which assets reset and which do not, the drawdown question rearranges itself. Spending from a traditional IRA during life uses up money that would have been fully taxable to heirs anyway; spending from a highly appreciated taxable account uses up an asset that would have passed with its gain erased.
For a household with both, that argues for drawing the traditional balance down harder in life — through withdrawals or conversions — and leaving the appreciated taxable holdings intact. It is the opposite of the reflex to preserve the tax-deferred account and spend the accessible one.
The same logic governs gifting. A gift carries your basis across; a bequest resets it. So cash and high-basis holdings are the right things to give during life, and the position with the largest embedded gain is the one thing you should not hand over early. And where a holding has fallen below cost, the step-up works against you: that loss is worth realising while you are alive rather than leaving to evaporate.
This is the provision that most often makes me tell someone to spend the account they were protecting. Households instinctively guard the IRA and live off the brokerage account, because the IRA feels like the retirement money and the brokerage feels like savings. On the inheritance arithmetic that is backwards: the IRA is the asset heirs will pay ordinary rates on, and the appreciated brokerage holding is the one that arrives with its gain erased. Nobody enjoys planning around their own death, but this is the single place where doing so changes what you should do this year.
FAQ
Do my heirs pay capital gains tax on investments they inherit?
Generally not on the gain that accumulated during your lifetime. Inherited assets take a basis equal to their date-of-death value, so only appreciation after that date is taxable to the heir. Selling shortly after inheriting typically produces little or no gain.
Does an inherited IRA get a step-up in basis?
No. Traditional IRAs and 401(k)s have no basis to step up, and the beneficiary pays ordinary income tax on every dollar withdrawn. This is the major exception, and it makes an inherited retirement account materially worse than a taxable account of the same value.
Is it better to gift an appreciated asset or leave it in my estate?
Leave it, in most cases. A gift carries your original basis to the recipient, so they inherit the unrealised gain. An asset passing at death resets to market value and that gain disappears — which is why cash and high-basis holdings are the better things to give during life.
Sources
Regulator references
- Publication 551, Basis of Assets · Internal Revenue Service · 2025How basis is determined for inherited property and for gifts.Last verified: 2026-09-07
- Publication 559, Survivors, Executors, and Administrators · Internal Revenue Service · 2025What the estate reports and how beneficiaries take property.Last verified: 2026-09-07
- Property, basis, sale of home, etc. · Internal Revenue Service · 2025Holding period and reporting for inherited assets when sold.Last verified: 2026-09-07
Calculator unit tests · the assertions this page's worked example is checked against, and their last result
Changelog
- 2026-09-07 — initial publish (new format)
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Jordan Reeves
Founder of Talk Through Wealth. A software engineer for over a decade before turning to retirement planning, Jordan built the projection engine after watching family members get fragmented, country-by-country advice that never reconciled. He writes about retirement the way the engine computes it: month-by-month, lifetime-long, and skeptical of any rule of thumb that hasn't been run through the math.