What is a step-up in basis, and why does it matter so much here?

When someone dies, the property they leave behind is treated as though the person inheriting it had paid what the property was worth on the date of death. Decades of appreciation simply stop being taxable. On a Palo Alto house bought in the 1970s, that single rule is routinely worth more than a million dollars — and in California, when the first spouse of a married couple dies, the whole house usually steps up rather than half of it. The catch is that it applies to what you inherit, and not to what you are given while the owner is alive.

Basis, in one paragraph

Tax on a sale is not charged on the price. It is charged on the gain, and the gain is the price minus your basis. Basis usually starts as what you paid and grows with what you spent on improvements.

So a Palo Alto house bought in 1974 for $78,000, with $200,000 of work done to it over fifty years, has a basis of roughly $278,000. Sell it for $4,000,000 during the owner’s lifetime and the gain is about $3.7 million.

That is the number the step-up erases.

What the step-up actually does

Property acquired from someone who has died takes a new basis: its fair market value on the date of death. Not what they paid. What it was worth the day they died.

The same house, inherited rather than bought, has a basis of $4,000,000. Sold soon afterwards for $4,000,000, the gain is zero. Fifty years of appreciation are not taxed, ever, by anybody.

Source: Internal Revenue Code §1014.

This is why the inherited-home conversation and the ordinary-sale conversation are so different. In an ordinary sale the receipts matter enormously. In an inherited sale they usually do not matter at all, because everything before the date of death has been wiped clean.

The California part, which is worth real money

Most of the country is a separate property state. When one spouse dies there, half the house steps up and the surviving spouse keeps their old basis on the other half.

California is a community property state, and community property gets treated differently: when the first spouse dies, both halves take the new date-of-death value.

Source: Internal Revenue Code §1014(b)(6).

On our $4M house, that is the difference between a basis of about $2.1 million and a basis of $4 million — roughly $1.9 million of gain that either exists or does not, depending on how the property was held and in which state.

Whether a particular house is community property is a legal question, not an obvious one. It depends on when and how it was acquired, what was done with title over the years, and what any trust says. A house one spouse owned before the marriage may not be community property at all. This is exactly the point at which an estate attorney earns their fee, and the answer is worth knowing before anyone dies, not after.

Get the date-of-death value written down

The step-up is only as good as your evidence for it.

If the house is sold within a few months of the death, the sale price is usually the best evidence there is, and no separate appraisal is needed. If the family keeps it for a few years and then sells, someone has to establish what it was worth on a date that has passed — and a retrospective appraisal commissioned years later is more expensive, more arguable, and sometimes impossible to do well.

The cheap version of this is a formal appraisal within a few months of the death, filed away. It costs a few hundred dollars. It is the difference between a number you can support and a number you are asserting.

Note also that the value and the mood of the market move. A date-of-death appraisal in a quiet January is a different number from the one a busy April would produce, and the one you are entitled to is the January number.

The mistake that costs the most

Property you are given during someone’s lifetime does not get a step-up. A gift carries the giver’s basis across with it — that same $278,000 — and the recipient inherits the whole gain along with the house.

Source: Internal Revenue Code §1015.

So the parent who adds an adult child to the deed “to keep things simple” has, in that moment, given away a share of a step-up that would otherwise have arrived automatically. It looks like tidy planning. It is frequently the single most expensive thing that happens to a Palo Alto family’s house, and nobody finds out until the sale.

There is a whole page on adding a child to the deed, because the question comes up constantly and the answer is almost always “talk to an estate attorney first”.

A revocable living trust is a different matter. Property in an ordinary revocable trust is still treated as the deceased person’s at death, so it takes the step-up in the normal way. Most Palo Alto houses are held this way, and it is one of the reasons a trust is such a common arrangement here. Irrevocable transfers are where the danger is — and the line between the two is a legal one, not something to judge from the name on a document.

Two different things called “basis”

This causes more confusion than any other part of the subject, so it is worth being blunt about it.

	What it decides	What resets at death
Income tax basis	Capital gains when you sell	Resets to date-of-death value
Property tax base	Your annual property tax bill	Usually reassessed — Prop 19

They share a word and they are unrelated. A family can get a perfect step-up for income tax purposes and still watch the annual property tax bill multiply, because Proposition 19 narrowed the parent-to-child exclusion sharply in 2021.

That is its own question, and it is the one that more often decides whether a family keeps the house.

What this means in practice

Selling soon after inheriting usually produces very little taxable gain. The basis is the date-of-death value and the sale price is close to it. Selling costs come off the top, which can even produce a small loss.

Holding for years means the gain starts accumulating again from the new basis. Ten years of Palo Alto appreciation on a $4M basis is a real taxable gain, and the §121 exclusion is only available to someone who has lived in the house as their main home for two of the last five years — which an out-of-state heir has not.

Renting it out changes the arithmetic again, because depreciation reduces basis over time and is recaptured on sale.

And the decision is rarely only about tax. Three siblings in three states with one house between them is a logistics problem before it is a tax problem. That is a different question.

Not legal or tax advice

Maggie is a licensed REALTOR® (DRE #02117367), not an attorney, a CPA or a tax adviser. What is on this page is a general description of how these rules work, with the code sections named so you or your professionals can check them, and it is current as of September 2026.

How they apply to a specific house depends on how it was held, what any trust says, who is inheriting and where they live — and those are questions for an estate attorney and a CPA, ideally in the same conversation. On a Palo Alto house the sums involved make that a cheap hour.

What Maggie can tell you is what the house is worth today, what a date-of-death valuation would need to be supported by, and what it would take to sell it well. That part is her job.

Maggie is a licensed REALTOR® (DRE #02117367), not an attorney, an accountant or a tax adviser. Everything here is general information about how these rules work in California, current as of the date on the page, and none of it is legal or tax advice for your family. Decisions about title, trusts and taxes should be made with an estate attorney and a CPA.