Step-up in basis, or stepped-up basis, occurs when Step-up in basis, or stepped-up basis, occurs when some asset that is inherited is worth more when the original owner dies than when they bought it. The tax code permits adjusting the cost basis to the higher value, which reduces potential capital gains taxes upon selling it (think selling a property). This provision applies to all heirs, not solely surviving spouses.
For instance, if Jane bought a stock at $2 and passed away when its market price was $15, a sale before her death would have incurred a capital gains tax on the $13 profit. However, the step-up in basis elevates the heir's cost basis to $15. Consequently, if the stock is later sold at that price, no capital gains tax would be applicable. The capital gains tax on the price rise from $2 to $15 is waived due to Jane's passing.
In community property states, a dual step-up benefit applies to jointly owned community property assets. For instance, if John and Jane co-own assets as community property and John passes away, Jane receives a step-up in basis on John's share of assets. When Jane subsequently passes away, a step-up in basis applies again, this time to the entire asset value.
Definitions
Cost Basis: The price paid for an item for tax purposes. When originally purchased it is exactly what was paid. If additional investments were made (re: upgrades to a house) those are added to the cost basis. It is basically what determines the baseline value of the asset so that we can determine the gain on the asset when sold which in turn determines if taxes are owed.
Step-Up in Basis Definition: The adjustment in the cost basis of an inherited asset to its fair market value on the date of the decedent's death.