Step-up basis is a method used for calculating the value of property that people inherit. Under a system that uses step-up basis, instead of using the value of the property at the time of the original purchase as a basis, people use the value of the property at the time of death. The advantage to doing this is that it reduces capital gains liability significantly. This is not allowed in all regions and people who are handling an estate should check with an attorney or accountant to find out whether the estate qualifies for adjustment under a step-up basis.
In a simple example of how step-up basis works, Fred buys stocks for $10 United States Dollars (USD) at some point prior to his death and wills them to his niece Susie. At the time of his death, the stocks were worth $40 USD. When Susie chooses to sell the stocks for $45 USD, she pays capital gains tax on the difference between $40 USD and $45 USD, not the difference between $10 USD and $45 USD. This means that her capital gains liability is much less.
It is also possible to step-down assets. Usually, assets rise in value between the time they are acquired and the death of the person who bought them. Sometimes, a dip in the market causes the value to drop, however. In these cases, the value of the assets would be stepped down to that fair market value at the time of death. If Fred died when the stocks were worth $8 USD, for example, that would be considered the value of the stocks at the time that Susie inherited them.
Real estate, stocks, and other investments all increase in value over time. Using a step-up basis for valuation is intended to be more fair to heirs, so that they are not penalized for the appreciation on the assets that happened during the decedent's lifetime.
The alternative to a step-up basis is carryover basis, where the value at the time of purchase is assumed to be the value of the goods at the time they are inherited. In some regions, people are required to use carryover basis for estate accounting. This can result in a significant hit on the capital gains tax in the event that these assets are sold. Generally, when property is transferred before death, it is valued on a carryover basis instead of a step-up basis, something to consider when people are making plans for the disposition of their estates and thinking of passing property on before they die.