The Section 1014 Basis Step-Up and Foreign Inherited Assets: What U.S. Heirs Need to Know

The basis step-up rule and why it matters

One of the most valuable provisions in the U.S. income tax code for heirs is the stepped-up basis rule under Internal Revenue Code Section 1014. When a U.S. person inherits property from a decedent, the heir's tax basis in the inherited property is generally stepped up to the fair market value of the property on the date of the decedent's death. This eliminates all of the capital gain that accrued during the decedent's lifetime — gain that might otherwise be taxable if the decedent had sold the property before death.

For a decedent who held appreciated stock or real estate for decades, the step-up can be worth millions of dollars in forgiven capital gains tax. It is one of the most significant tax benefits available to heirs under current U.S. law.

Does the step-up apply to foreign assets?

Yes — Section 1014 applies to property acquired from a decedent regardless of whether the property is located in the United States or abroad, and regardless of the nationality or domicile of the decedent. A U.S. heir who inherits foreign real estate, foreign stock, or foreign financial accounts from a foreign parent or grandparent is entitled to a basis step-up under U.S. tax law, just as if the property were domestic.

The practical effect is significant: if a U.S. person inherits highly appreciated foreign real estate from a foreign parent, the U.S. income tax basis in that property is stepped up to fair market value at the date of death. If the heir subsequently sells the property, only post-death appreciation is taxable for U.S. income tax purposes — the lifetime appreciation accrued during the decedent's ownership is permanently excluded from U.S. income tax.

Establishing fair market value for foreign assets

The challenge with applying the step-up to foreign assets is establishing and documenting the fair market value of those assets at the date of death. For publicly traded foreign securities, fair market value is the average of the high and low trading prices on the date of death — straightforward in principle but requiring the heir to obtain historical price data in some cases. For foreign real estate, a qualified appraisal by a local real estate appraiser is typically required.

The valuation must be documented at the time of inheritance — not reconstructed years later when the property is eventually sold. Heirs who fail to obtain valuations at the time of inheritance may find it difficult to establish the stepped-up basis when they eventually sell, potentially resulting in a larger recognized gain than they are legally required to report.

Interaction with the foreign estate: was the asset included in a taxable estate?

Section 1014 generally provides a stepped-up basis for property included in the decedent's gross estate for U.S. estate tax purposes. For foreign decedents who are non-resident aliens, only U.S.-situs assets are included in the U.S. taxable estate — foreign assets generally are not. However, the step-up under Section 1014 is not strictly limited to estate-tax-included property: property acquired from a decedent by reason of death, form of ownership, or other circumstances giving rise to a right of survivorship qualifies, even if not subject to U.S. estate tax.

What does not get a step-up

Not all inherited assets receive a stepped-up basis. Income in respect of a decedent (IRD) — items the decedent had a right to receive but had not yet received at death, such as unpaid salary, IRA distributions, and installment sale proceeds — does not receive a basis step-up and is taxable as ordinary income when received by the heir. Foreign pension accounts and deferred compensation items that constitute IRD are particularly important to identify correctly, as misapplying the step-up to IRD items results in understated income.

If you have inherited foreign assets — real estate, securities, business interests, or financial accounts — understanding the basis step-up rules is essential before you sell. Our attorneys can help you document the inherited basis, analyze the applicable tax rules, and plan the most tax-efficient disposition. Contact us today.