Yes, a legally adopted child absolutely gets a stepped-up basis on inherited property. For all legal and tax purposes in the United States, an adopted child has the exact same rights as a biological child. The core issue arises from the intersection of two different sets of laws: state adoption laws and federal tax laws. The primary conflict is that the federal tax rule governing this benefit, Internal Revenue Code (I.R.C.) § 1014, does not explicitly mention “adopted children,” which can cause confusion.
This lack of specific language creates a risk that an adopted heir, or even an executor of an estate, might mistakenly use the wrong value for an inherited asset, leading to a massive and unnecessary capital gains tax bill. With over 135,000 children adopted in the U.S. each year, understanding this rule is critical for countless families. This guide will provide the clarity you need to protect your family’s wealth.
Here is what you will learn:
- ✅ The Simple Answer & The Law Behind It: Understand why adopted children automatically qualify for this powerful tax break and the specific federal statute that makes it happen.
- 💰 How Stepped-Up Basis Saves You Thousands: See clear, real-world examples of how this rule works on a house or stock portfolio, potentially erasing decades of taxable gains.
- 📜 The Critical Difference Between Inheriting vs. Gifting: Learn why passing property at death is often far more tax-efficient than giving it away during your lifetime, a mistake that can cost families a fortune.
- ⚠️ Common Mistakes & How to Avoid Them: Discover the most frequent and costly errors families make in estate planning for adopted children and learn simple ways to prevent them.
- 🗺️ State-Specific Rules That Can Double Your Benefit: Find out how living in one of nine “community property” states can provide an extra, even more powerful version of the stepped-up basis for a surviving spouse.
The Three Pillars of Stepped-Up Basis: Basis, Gains, and the Magic Eraser
To understand why this tax rule is so important, you first need to grasp three simple but connected ideas. These are the building blocks that determine how much tax you owe when you sell an inherited asset. They are the asset’s cost basis, the capital gain, and the special inheritance rule called the stepped-up basis.
Pillar 1: What Is “Cost Basis”? The Starting Point for Taxes
The cost basis is simply the original value of an asset for tax purposes. For something you buy, like a house or a stock, the basis is usually its purchase price. You can increase this basis by adding the cost of major improvements.
Imagine you buy a small house for $150,000. That’s your starting cost basis. If you then spend $50,000 on a new kitchen and bathroom, your adjusted cost basis becomes $200,000. This new, higher number is what the IRS uses to figure out your profit when you sell.
Pillar 2: What Are “Capital Gains”? Your Taxable Profit
A capital gain is the profit you make when you sell an asset for more than its adjusted cost basis. The calculation is simple: Sale Price minus Cost Basis equals your Capital Gain. This profit is what gets taxed.
Using the house example, if your adjusted cost basis is $200,000 and you sell it for $450,000, your capital gain is $250,000. That $250,000 is the amount the government will tax. The tax rate depends on how long you owned the asset, with assets held for more than a year getting taxed at lower long-term rates.
Pillar 3: What Is “Stepped-Up Basis”? The Inheritance Tax Break
This is where the magic happens for heirs. The stepped-up basis is a special rule that applies only to assets passed down at death. Under this rule, the cost basis of an inherited asset is not the original purchase price. Instead, the basis is “stepped up” to the asset’s fair market value (FMV) on the date the original owner died.
This revaluation effectively erases all the taxable profit that built up during the original owner’s lifetime. The heir receives the asset as if they had just bought it for its full market price on the day of inheritance. This means if they sell it shortly after, there is little to no capital gains tax to pay.
The Law: Why Adopted Children Are Automatically Included
The reason adopted children get a stepped-up basis isn’t found in a single tax sentence. It’s found in the powerful connection between state family law and federal tax law. One defines what a “child” is, and the other grants that child a tax benefit.
State Law Creates the Family, Federal Law Provides the Benefit
The entire foundation of modern U.S. adoption law is the principle of legal equivalence. When an adoption is finalized, the law creates a new, permanent parent-child relationship that is identical to a biological one. The adopted child gains all the rights of a natural-born child, including the absolute right to inherit.
This is where the federal tax law, I.R.C. § 1014, comes in. This statute says that the basis of property acquired from a decedent by “bequest, devise, or inheritance” shall be its fair market value at the date of death. Because state law universally defines an adopted child as a full legal heir who receives property through “inheritance,” they automatically qualify for the stepped-up basis provided by federal tax law.
The IRS Confirms It: An Adopted Child Is a “Child”
Any doubt is removed by the Internal Revenue Service (IRS) itself. In its official publications, such as Publication 523, the IRS explicitly includes an “adopted child” and “stepchild” in its definition of a “child” for tax purposes. This direct confirmation means there is no distinction between biological and adopted children when it comes to tax rules related to family and inheritance.
The law sees no difference, and neither does the taxman. An adopted child is a child, period.
Three Scenarios: Seeing the Stepped-Up Basis in Action
Abstract rules can be confusing. Let’s look at three common, real-world scenarios to see the dramatic financial impact of the stepped-up basis for an adopted heir. We’ll explore inheriting a home, a stock portfolio, and an asset that has lost value.
Scenario 1: Inheriting the Family Home
Maria and David adopted their son, Leo. In 1995, they bought a house for $200,000. Over the years, they spent $50,000 on improvements, making their adjusted cost basis $250,000. When the last parent passes away, the home is worth $900,000. Leo inherits the house.
Because of the stepped-up basis, Leo’s new cost basis is reset to the home’s value on the date of death: $900,000. The $650,000 in appreciation that occurred during his parents’ lives is completely erased for tax purposes. If Leo sells the house a month later for $910,000, he only pays capital gains tax on his small $10,000 profit.
Now, compare this to what would happen if his parents had gifted him the house before they passed away.
| Transfer Method | Heir’s Tax Situation |
| Inheritance at Death | Leo’s basis is stepped up to $900,000. When he sells for $910,000, his taxable capital gain is only $10,000. |
| Lifetime Gift | Leo receives a carryover basis of $250,000 (his parents’ basis). When he sells for $910,000, his taxable capital gain is a massive $660,000. |
Scenario 2: Inheriting a Stock Portfolio
Sarah and Tom adopted their daughter, Chloe. In 2004, they invested $100,000 in stocks. When the last parent dies, the portfolio has grown to be worth $750,000. Chloe inherits the stocks.
Chloe’s basis in the stock portfolio is stepped up from the original $100,000 to the date-of-death value of $750,000. The $650,000 gain her parents enjoyed is never taxed. If Chloe sells the entire portfolio a few months later for $765,000, she only owes capital gains tax on the $15,000 of growth that happened after she inherited it.
| Action | Financial Consequence |
| Parents’ Original Investment | Cost Basis: $100,000 |
| Value at Inheritance | Chloe’s new stepped-up basis becomes $750,000. The $650,000 gain is tax-free. |
| Chloe Sells Portfolio | Sale Price: $765,000. Taxable Capital Gain: $15,000 ($765,000 – $750,000). |
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Scenario 3: The “Step-Down” in Basis When an Asset Loses Value
The basis adjustment isn’t always a “step up.” If an asset has decreased in value, the heir receives a “step-down” in basis, which can be a disadvantage.
An adoptive parent buys 100 shares of a tech stock for $150,000. By the time they pass away, the stock has fallen in value to $90,000. Their adopted child inherits the stock. The child’s basis is “stepped down” to the $90,000 fair market value. The original $60,000 paper loss is gone forever and cannot be used by the heir.
If the stock later recovers and the child sells it for $120,000, they will have a taxable capital gain of $30,000, even though the sale price is less than what their parent originally paid.
| Event | Asset Value & Tax Basis |
| Parent’s Original Purchase | Cost Basis: $150,000 |
| Value at Inheritance | The heir’s basis is stepped down to the fair market value of $90,000. |
| Heir Sells After Recovery | Sale Price: $120,000. Taxable Capital Gain: $30,000 ($120,000 – $90,000). |
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Critical Decision: The Tax Consequences of Gifting vs. Inheriting
One of the most important—and often misunderstood—decisions in estate planning is whether to give a valuable asset to a child during your lifetime or to pass it to them in your will. The tax consequences are dramatically different. Making the wrong choice can trigger a huge, avoidable tax bill for your child.
When you inherit an asset, you get the powerful benefit of a stepped-up basis. The asset’s tax value is reset to its fair market value on the date of death, wiping out any capital gains tax on the appreciation that occurred during the owner’s life.
When you receive an asset as a gift, you get a carryover basis. This means you, the recipient, take on the original owner’s cost basis. You also take on the responsibility for paying capital gains tax on all the appreciation that has built up since the asset was first purchased.
| Comparison Point | Transfer via Inheritance (at Death) | Transfer via Gift (During Life) |
| Recipient’s Cost Basis | Stepped-Up Basis: Fair Market Value on the date of the owner’s death. | Carryover Basis: The original owner’s purchase price and adjustments. |
| Tax on Built-Up Gain | Forgiven. The capital gain that accrued during the original owner’s life is eliminated for tax purposes. | Transferred. The recipient is now responsible for the tax on all the appreciation from the very beginning. |
| Example (Asset bought at $100k, now worth $600k) | The child’s new basis is $600,000. If they sell it for $600,000, their taxable gain is $0. | The child’s basis is $100,000. If they sell it for $600,000, their taxable gain is $500,000. |
| Best For | Highly appreciated assets like real estate, stocks, or a family business where you want to maximize tax savings for your heir. | Assets you expect to grow much more in value, or when the recipient has an immediate financial need for the asset. |
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Mistakes to Avoid: Common and Costly Estate Planning Errors
For families with adopted children, a few simple oversights can lead to unintended consequences, family disputes, and unnecessary taxes. Being aware of these common mistakes is the first step to creating a plan that truly protects everyone you love.
- Mistake 1: Assuming Stepchildren Automatically Inherit. This is a huge and frequent error. Unless you legally adopt your stepchild, they have no automatic right to inherit from you if you die without a will. To provide for a stepchild, you must explicitly name them in your will or trust.
- Mistake 2: Using Vague Language like “My Children.” While it seems clear, using general terms like “my children” or “my descendants” in a will can create ambiguity, especially in blended families. The best practice is to list every single child—biological, adopted, and stepchildren you wish to include—by their full legal name to eliminate any doubt.
- Mistake 3: Gifting Appreciated Property and Losing the Step-Up. As shown in the scenarios above, gifting a highly appreciated asset (like a house or stock) during your lifetime is often a major tax mistake. The recipient gets your old, low cost basis and a future tax headache. Letting them inherit it instead preserves the powerful stepped-up basis benefit.
- Mistake 4: Forgetting to Update Beneficiary Designations. Many valuable assets pass outside of a will. These include life insurance policies, 401(k)s, IRAs, and bank accounts with “Payable on Death” (POD) designations. After an adoption, you must review and update the beneficiary forms for each of these accounts to add your new child.
- Mistake 5: Not Funding Your Trust. Creating a living trust is a great way to avoid probate, but the trust document itself does nothing. You must legally transfer your assets—like retitling your house or changing the owner of your brokerage account—into the name of the trust. An unfunded trust is just an empty box that won’t help your heirs.
State Law Nuances: Where You Live Matters
While the stepped-up basis is a federal tax rule, state laws play a huge role in how it’s applied, especially for married couples. The U.S. is divided into two systems for marital property: common law states and community property states. The difference can mean hundreds of thousands of dollars in extra tax savings.
The “Double Step-Up” Advantage in Community Property States
Nine states are community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In these states, most property acquired during a marriage is considered owned 50/50 by both spouses, regardless of whose name is on the title.
These states offer a massive tax advantage called the “double step-up.” When the first spouse dies, both halves of the community property get a full step-up in basis to the current market value. This includes the deceased spouse’s share and the surviving spouse’s share.
The Partial Step-Up in Common Law States
In the other 41 common law states, assets are owned by the person whose name is on the title. For jointly owned property, when one spouse dies, only the deceased spouse’s half of the asset gets a stepped-up basis. The surviving spouse’s half keeps its original, old cost basis.
Let’s see how this plays out with a house bought for $200,000 that is now worth $1,200,000.
| Marital Property System | Tax Basis for Surviving Spouse |
| Common Law State | Only the deceased spouse’s 50% share gets a step-up. The new basis is $700,000 ($600,000 for the stepped-up half + $100,000 for the survivor’s original half). A sale at $1.2M creates a $500,000 taxable gain. |
| Community Property State | Both 50% shares get a full step-up. The new basis is $1,200,000 ($600,000 + $600,000). A sale at $1.2M creates a $0 taxable gain. |
Special Adoption Scenarios and Their Inheritance Impact
Adoption isn’t always about infants. The law allows for different types of adoptions that create unique inheritance situations. Understanding these special cases is key to ensuring your estate plan works as intended.
Can You Adopt an Adult to Give Them Inheritance Rights?
Yes, most states allow for adult adoption. This is often used to formalize a long-standing parent-child relationship, such as with a stepchild or foster child you’ve raised. A primary motivation for adult adoption is to legally establish inheritance rights.
Once an adult adoption is finalized by a court, the adoptee becomes a full legal child of the adoptive parent. They gain the automatic right to inherit if the parent dies without a will and, crucially, any property they inherit qualifies for a stepped-up basis.
How Does a Stepparent Adoption Change Inheritance?
Stepparent adoption is very common and creates a unique legal status. When a stepparent adopts their stepchild, that child gains full inheritance rights from the adoptive stepparent.
Depending on the state, the child may also retain their right to inherit from and through their other biological parent’s family line. This is especially true if the adoption happened after the other biological parent died. This can create a situation where a child is the legal heir to three people: two biological parents and one adoptive stepparent.
What Is “Equitable Adoption” When a Legal Adoption Fails?
Equitable adoption is a legal safety net used in some states when a parent intended to adopt a child but never completed the legal process. If a person can prove with “clear and convincing evidence” that a parent-figure promised to adopt them and treated them as their own child, a court may grant them the status of a child for inheritance purposes.
If a court rules in favor of an equitable adoption, the child can inherit from the parent’s estate as if they were legally adopted. This would also make them eligible for the stepped-up basis on that property. However, these cases often require expensive and difficult court battles and are not a substitute for a legal adoption or a clear will.
Do’s and Don’ts for Estate Planning with Adopted Children
A little bit of planning goes a long way. Following these simple do’s and don’ts can help you avoid common pitfalls and ensure your estate plan accurately reflects your love for your entire family.
| Do’s | Don’ts |
| ✅ DO update your will and trust immediately after an adoption is finalized. | ❌ DON’T rely on state intestacy laws to distribute your property. |
| ✅ DO list every child by their full legal name to avoid ambiguity. | ❌ DON’T use vague terms like “my issue” or “my descendants.” |
| ✅ DO update beneficiary forms for life insurance, IRAs, and 401(k)s. | ❌ DON’T assume your will controls all of your assets. |
| ✅ DO treat all children—biological and adopted—equally to prevent disputes, unless you have a specific reason not to. | ❌ DON’T assume unadopted stepchildren will automatically inherit anything. |
| ✅ DO communicate your general intentions with your family to manage expectations and reduce future conflict. | ❌ DON’T forget to fund your trust by retitling assets into its name. |
Pros and Cons of the Stepped-Up Basis Rule
The stepped-up basis is a huge benefit for most heirs, but it’s not without its nuances. Understanding both the advantages and potential disadvantages can help you make smarter estate planning decisions.
| Pros of Stepped-Up Basis | Cons of Stepped-Up Basis |
| 👍 Erases Capital Gains: It completely eliminates the capital gains tax on all appreciation that occurred during the original owner’s lifetime. | 👎 Can Result in a “Step-Down”: If an asset has lost value, the basis is stepped down, and the original capital loss is permanently erased. |
| 👍 Simplifies Record-Keeping: Heirs don’t need to track down decades-old purchase records to figure out the original cost basis. The new basis is simply the value at death. | 👎 Doesn’t Apply to Retirement Accounts: Assets like traditional IRAs and 401(k)s do not get a step-up. Beneficiaries owe ordinary income tax on withdrawals. |
| 👍 Encourages Holding Assets: It allows families to hold onto valuable assets like a family home or business for generations without being forced to sell to pay a large tax bill. | 👎 Can Create a “Lock-In” Effect: Owners may hold onto appreciated assets they would otherwise sell, simply to avoid paying capital gains tax during their lifetime. |
| 👍 Applies to Most Capital Assets: The rule covers a wide range of assets, including real estate, stocks, bonds, mutual funds, and collectibles. | 👎 Benefit is Not Universal: The tax savings primarily benefit those who inherit appreciated assets, which are disproportionately held by wealthier households. |
| 👍 Can Be Used Again: An asset can receive a step-up in basis multiple times as it is passed down from one generation to the next. | 👎 Subject to Political Change: The rule is often debated by lawmakers and has been targeted for elimination in the past, making its future uncertain. |
The Process: How to Document and Claim the Stepped-Up Basis
Claiming the stepped-up basis isn’t automatic; you need to properly document the asset’s value. This process is managed by the executor of the estate, but as an heir, it’s crucial to understand the steps and get the right paperwork for your records.
Step 1: The Executor Determines the Fair Market Value (FMV)
The executor is legally responsible for inventorying and valuing all of the decedent’s assets. The value used is the Fair Market Value on the date of death. The executor has the option to use an “alternate valuation date,” which is six months after the date of death, but only if doing so lowers both the total value of the estate and the estate tax owed.
Step 2: Getting the Right Valuation for Each Asset Type
Different assets require different methods of valuation to satisfy the IRS.
- For Real Estate (Homes, Land): The executor must hire a qualified real estate appraiser to conduct a professional appraisal. The appraiser will create a formal report that establishes the property’s value as of the date of death. As an heir, you should request a copy of this appraisal for your tax records.
- For Publicly Traded Stocks and Bonds: The value is determined by the average of the high and low trading prices on the date of death. This information can be found on brokerage statements or through historical stock price websites. The executor will compile this information, and you should keep copies of the relevant statements.
- For Private Businesses, Art, or Collectibles: These unique assets require a formal appraisal from a specialist in that field. For a business, this means a complete business valuation. For art or rare collectibles, it requires an expert appraiser.
Step 3: The Heir’s Responsibility: Keep Good Records
Once the executor provides you with the valuation information, your job is to keep it in a safe place. You will need this documentation if you ever sell the asset to correctly calculate your capital gains tax.
If the estate was large enough to require filing a federal estate tax return (Form 706), the values reported on that return are binding. You must use the value listed on the Form 706 as your cost basis. The executor should provide you with a statement (Form 8971 and its Schedule A) detailing the value of the property you inherited.
FAQs: Quick Answers to Common Questions
Is an adopted child treated differently from a biological child for any inheritance tax purposes?
No. For all federal tax purposes, a legally adopted child is treated exactly the same as a biological child. State inheritance taxes also typically treat adopted children as the most favored class of beneficiary.
What happens if my adoptive parent dies without a will? Do I still get a stepped-up basis?
Yes. State laws, known as intestacy laws, treat adopted children the same as biological children. You will inherit through this legal process, and any assets you receive will qualify for the stepped-up basis.
Do I get a stepped-up basis if my biological parent leaves me property in their will?
Yes. While adoption severs your automatic right to inherit from a biological parent, they can still choose to name you in their will. In this case, the property is acquired by “bequest,” which qualifies for a stepped-up basis.
Are there any inherited assets that do not receive a stepped-up basis?
Yes. The rule does not apply to “Income in Respect of a Decedent” (IRD). This includes tax-deferred retirement accounts like traditional IRAs and 401(k)s, which are taxed as ordinary income to the beneficiary.
Does it matter if the adoption was domestic or international?
No. As long as a foreign adoption is legally recognized in the U.S., the adopted child is a full legal heir and qualifies for the stepped-up basis on inherited U.S. assets. Inheriting foreign assets involves separate reporting rules.
Do assets inherited from a foreign person get a stepped-up basis?
Yes. Generally, foreign assets inherited by a U.S. person are eligible for a stepped-up basis under U.S. tax law, even if no U.S. estate tax was paid. However, specific reporting requirements, like filing Form 3520, apply.
What documentation do I need to prove the stepped-up basis?
You need documentation showing the asset’s fair market value on the date of death. This includes professional appraisals for real estate, brokerage statements for stocks, and formal valuations for businesses. The estate’s executor should provide this.