What step-up in basis means

When you inherit an asset, the federal tax code generally allows you to use the asset's fair market value at the date of the decedent's death as your cost basis, rather than what the decedent originally paid. This reset is called the step-up in basis (or sometimes stepped-up basis). The practical effect is that all the capital gains that accumulated during the decedent's lifetime are never taxed at the federal level. If you then sell the inherited asset shortly after inheriting it at roughly the same price, you owe little or no capital gains tax.

Consider a concrete example. Your parent purchased a California home in 1985 for $100,000. At their death, the home is worth $1.2 million. Your inherited basis is $1.2 million, not $100,000. If you sell the home for $1.2 million, you have no capital gain. If you wait and sell five years later for $1.4 million, you have a $200,000 capital gain, not a $1.1 million capital gain. The step-up eliminates the tax on that $1.1 million of lifetime appreciation entirely.

The step-up in basis applies to assets held in a decedent's taxable estate, including real estate held individually, jointly with rights of survivorship, or in a revocable living trust. Assets in a properly structured irrevocable trust generally do not receive a step-up at the grantor's death, which is an important planning consideration. California conforms to federal treatment in this area. Consult a tax professional or estate planning attorney for guidance specific to your situation.

Why it matters for trust and probate loans

Understanding step-up in basis helps heirs evaluate whether to keep or sell inherited California property. A trust or probate loan can provide the flexibility to make that decision without being forced by a financial deadline. Heirs who need cash during estate administration sometimes feel pressured to sell quickly, even when selling quickly is not in their best financial interest. A short-term trust or probate loan can cover immediate financial needs, giving heirs time to evaluate the tax consequences of a sale versus a hold strategy.

The step-up in basis also interacts with Proposition 19. An heir who wants to keep a parent's home and preserve the low property tax basis under Prop 19 may need a buyout loan to compensate co-heirs. That heir also benefits from the step-up in basis, since their cost basis in the property is the fair market value at death, not the original purchase price. North Coast Financial funds these loans throughout California with rates from 9.5% to 10.95% and origination of 1.25 to 1.95 points.

Related terms

See also: Proposition 19, Parent-child exclusion, Beneficiary vs. heir, and our main article on trust loans in California.

Frequently Asked Questions

Does California have its own capital gains tax on inherited property?
California taxes capital gains as ordinary income and conforms to the federal step-up in basis rules. That means when you inherit California real estate, your state income tax basis is also stepped up to the fair market value at date of death. If you sell the property shortly after inheriting at roughly the same value, you generally owe little or no California income tax on the sale, just as with the federal tax. California does not have a separate inheritance tax or estate tax.
What happens to the basis if property is transferred to a trust during the grantor's lifetime?
Property in a revocable living trust is included in the grantor's taxable estate at death and receives a full step-up in basis. Property transferred to an irrevocable trust during the grantor's lifetime may or may not receive a step-up depending on whether the assets are included in the grantor's estate. This is a key reason why some estate planners prefer structures that keep assets in the estate for basis step-up purposes even when there are other planning goals. Consult an estate planning attorney for guidance on your specific trust structure.
Can a trust or probate loan help preserve the step-up benefit?
Indirectly, yes. A trust or probate loan can prevent heirs from being forced to sell inherited property prematurely due to cash flow needs. If a sale is forced before the estate is fully administered, the heir may lose the opportunity to properly document the stepped-up basis, or may sell at a price that does not reflect the property's full fair market value. A loan gives the estate breathing room to complete administration on its own timeline, in consultation with tax counsel, and to sell when conditions are favorable.