Step-Up in Basis for Trust Assets: What Every Successor Trustee Must Know

One of the most valuable — and most misunderstood — events in trust administration is the automatic reset of cost basis at the settlor's death. Getting this right saves beneficiaries tens of thousands of dollars in unnecessary capital gains taxes. Getting it wrong, or failing to document it, is a trustee mistake you can't easily fix later.

What step-up in basis means

Under IRC § 1014, when a decedent's property passes to heirs — whether outright or through a trust — its cost basis is reset to fair market value on the date of death.¹ If the settlor paid $50,000 for stock that grew to $350,000 over 30 years, and that stock is in the trust when they die, the trust (and ultimately the beneficiaries) now hold stock with a $350,000 basis — not $50,000. If the trust sells the stock the next day, the capital gain is zero.

For a typical parent's revocable trust holding a $2M investment portfolio built over decades, the embedded gains can easily exceed $500,000–$800,000. Understanding which assets get this reset — and which don't — is one of the first things a new successor trustee needs to get right.

Does a revocable living trust qualify?

Yes. Assets held in a revocable living trust at the settlor's death are included in the settlor's taxable gross estate for federal estate tax purposes.² Because they're included in the gross estate, they qualify for the step-up under IRC § 1014. This is true regardless of whether the estate owes any estate tax (most don't, given the 2026 federal exemption of $15 million per individual under the One Big Beautiful Bill Act).³

When the settlor dies, the revocable trust becomes irrevocable — and all the investment assets in it, real estate, closely-held business interests, and other property receive a new basis as of that date. The trust's EIN changes, the Form 1041 filing obligation begins, and the portfolio's embedded gain clock resets to zero.

Which assets get stepped up

Assets that receive a stepped-up basis at the settlor's death:

• Investment accounts held in the trust's name — stocks, bonds, mutual funds, ETFs. Each position receives a new basis equal to its closing price on the date of death (or average of high/low for thinly traded securities).
• Real estate titled in the trust — fair market value as of date of death, typically established by a formal appraisal. This is one of the most significant opportunities; real estate held decades often has huge embedded gain.
• Closely held business interests — equity in partnerships, LLCs, or S corporations held in the trust receives a step-up. Business interests require a qualified appraisal to establish the date-of-death FMV.
• Other capital assets — collectibles, art, precious metals, and other property held in the trust that would otherwise produce capital gain on sale.

Which assets do NOT get stepped up

Several categories of assets are explicitly excluded from the step-up under IRC § 1014(c). These are called income in respect of a decedent (IRD) — income the decedent was entitled to receive but hadn't yet recognized for income tax purposes.⁵

• Traditional IRAs and 401(k)s. Distributions from inherited IRAs are ordinary income to the beneficiary, not capital gain — there is no basis to step up, because the decedent never paid income tax on these funds. This applies whether the IRA was payable to the trust or directly to a named beneficiary.
• Annuities. The growth inside a deferred annuity is IRD; it comes out as ordinary income when distributed, with no basis reset at death.
• Installment notes. If the settlor sold an asset before death and was receiving installment payments, the remaining gain in those payments is IRD.
• U.S. savings bond accrued interest. The interest that has accrued but not been recognized is IRD.
• Roth IRA accounts. These don't need a step-up because qualified distributions are already tax-free — but the account itself does not receive a basis adjustment at death in any meaningful sense.

For a successor trustee managing a large estate, the IRD assets often represent a significant tax obligation that will be borne by whoever receives them. Modeling the after-tax value of the total estate — including the IRD "shadow" — is something a financial advisor can run before you make distribution decisions.

The documentation requirement: your critical first step

The step-up in basis is automatic under the tax code, but the value at which the basis is set is not automatic — it requires documentation. As successor trustee, you must establish and record the fair market value of every trust asset as of the date of death. Failing to do this properly leaves beneficiaries unable to prove their basis when they eventually sell, and leaves you exposed to the argument that you failed to properly administer the trust.

Publicly traded securities

For stocks, bonds, ETFs, and mutual funds, the brokerage custodian typically calculates and records the date-of-death values. Request a formal date-of-death valuation statement from each custodian. This is a standard service — all major custodians (Schwab, Fidelity, Vanguard, etc.) provide it. Keep these statements in the trust file permanently.

Real estate

A qualified real estate appraisal is required to establish date-of-death FMV for real property.⁶ Order the appraisal promptly after the settlor's death — appraisers can back-date to the date of death, but the further out you are, the harder it becomes to defend the valuation. For estate tax purposes, the appraisal is required for Form 706; even if the estate doesn't owe tax, you'll want the appraisal to document the beneficiaries' new basis.

Closely held business interests

A business valuation (qualified appraisal meeting IRC § 170(f)(11) standards) is required for private business interests. This is typically done by a certified business appraiser. It's more expensive than a real estate appraisal — budget $5,000–$20,000+ depending on complexity — but the tax savings from establishing a high step-up value on a business worth $500K–$5M easily justify the cost.

Alternate valuation date: rarely used, worth knowing

IRC § 2032 allows an estate to elect to value assets six months after the date of death instead of on the date of death — but only if doing so reduces both (1) the gross estate value and (2) the combined estate and generation-skipping transfer taxes owed.⁷ With the 2026 exemption at $15 million, most trusts in the $500K–$5M range won't owe any estate tax, so this election is rarely relevant. If the estate does exceed the exemption and the market declined sharply after the date of death, the alternate valuation date could reduce both estate tax and the beneficiaries' stepped-up basis. This is a decision for your estate attorney and CPA working together.

Investment decisions after the step-up

The step-up creates a short window of opportunity that an experienced advisor will identify immediately: should we sell appreciated assets while the basis is high?

Right after the settlor's death, the trust's embedded gain may be near zero. Any positions you sell in that window produce little or no capital gain. Over time, as the portfolio grows, new gain accrues. This argues for reviewing the inherited portfolio's allocation promptly — not because the trust should sell everything, but because there's never a better time to rebalance, eliminate concentrated positions, or align the portfolio with the trust's actual investment policy without triggering a large tax bill.

The opposing consideration: trust capital gains are taxed at highly compressed brackets. For 2026, trusts reach the 20% long-term capital gains rate at only $3,250 of gain. Distributing appreciated assets to beneficiaries — where the lower individual brackets apply — before selling may be more tax-efficient than selling inside the trust. This is exactly the kind of distribute-vs.-accumulate analysis that a fee-only advisor runs for trustees.

Community property: the double step-up

For married couples in community property states (California, Texas, Arizona, Washington, Wisconsin, Nevada, New Mexico, Idaho, Louisiana), there is an additional step-up available under IRC § 1014(b)(6).¹ When one spouse dies, both halves of community property assets receive a step-up — not just the decedent's half. This "double step-up" is a major tax benefit available only in community property states, and only for assets that were properly characterized as community property during the marriage.

If you are administering a trust that contains community property, confirm with the estate attorney that the assets were properly titled and characterized. The double step-up is not automatic if the community property character was lost or the assets were commingled with separate property.

Common trustee mistakes to avoid

• Failing to get valuations promptly. Real estate and business appraisals must be ordered early. Appraisers can back-date, but delays raise questions about methodology and defensibility.
• Not retaining valuation documentation permanently. Beneficiaries may sell these assets 10–20 years from now. The basis documentation needs to survive that long. Store it in the trust file and consider giving beneficiaries copies when assets are distributed.
• Assuming all trust assets get the step-up. IRAs payable to the trust, annuities, and other IRD assets are treated differently. Distributing these to beneficiaries as if they have a stepped-up basis, when they don't, is a material error.
• Missing the concentrated position window. The period right after the settlor's death, when basis is freshly reset, is often the best time to diversify a concentrated position. Trustees who sit on highly concentrated portfolios for years after death — letting new gain accumulate — have foregone this opportunity.
• Ignoring the trust's tax bracket on accumulated gains. If the trust is going to accumulate income rather than distribute it, capital gains above a low threshold will be taxed at 20% (plus the 3.8% net investment income tax). Understanding when to distribute vs. accumulate requires modeling the trust's income alongside the beneficiaries' individual tax situations.

Role of a financial advisor in basis planning

A fee-only advisor working with the successor trustee will typically:

• Coordinate with the custodians to obtain date-of-death valuations for all securities accounts
• Identify which assets are IRD vs. eligible for the step-up, and model the after-tax value of each category
• Run a distribute-vs.-accumulate analysis for appreciated assets in light of the trust's vs. beneficiaries' tax brackets
• Identify concentrated positions that are most advantageous to rebalance in the first year after death
• Document the investment policy and transaction rationale, satisfying the UPIA process standard

The basis step-up is a one-time, time-sensitive opportunity. Getting it right — documenting it, modeling the decisions around it, and acting in the window before new gain accrues — is one of the highest-value things a new successor trustee can do for the beneficiaries in the first year of administration.

Sources

1. IRC § 1014 — Basis of Property Acquired from a Decedent (LII/Cornell). Establishes the step-up to date-of-death FMV; § 1014(b)(6) provides the community property double step-up; § 1014(c) excludes IRD assets.
2. IRS Publication 559 — Survivors, Executors, and Administrators (2025). IRS guidance on income in respect of a decedent, basis rules for inherited property, and IRD deduction.
3. One Big Beautiful Bill Act (OBBBA), July 2025. Permanently raised the federal estate and gift tax exemption to $15 million per individual, eliminating the prior scheduled sunset.
4. Rev. Rul. 2023-2 — IRS Ruling on Basis in Irrevocable Grantor Trusts. Assets in an irrevocable trust not included in the grantor's gross estate do not receive a step-up at death.
5. IRS Publication 559 — Income in Respect of a Decedent. Explains which assets are IRD (IRAs, annuities, installment notes) and how they are taxed when distributed to beneficiaries or the estate.
6. Instructions for Form 706 — United States Estate (and Generation-Skipping Transfer) Tax Return. Appraisal and valuation standards for estate assets including real property and business interests.
7. IRC § 2032 — Alternate Valuation (LII/Cornell). Allows estate to elect valuation 6 months after death, but only if doing so reduces both gross estate value and estate/GST taxes owed.

Tax rules discussed reflect 2026 federal law, including the One Big Beautiful Bill Act signed July 2025. State laws vary on community property characterization and trust administration requirements. Consult your estate attorney and CPA for jurisdiction-specific guidance. Values verified as of April 2026.