Unlike most other assets, savings bonds do not get a basis step up at death, because they are "income in respect of a decendent." All income the decedent would have received had death not occurred that was not properly includible on the final return, is income in respect of a decedent
In most cases the deceased owner of the bond fails to include the bond's accumulated interest on his or her tax return each year. The accumulated interest in therefore reported on the transferee's tax return when the bond is redeemed.
But if the owner reported the interest each year, the increase in value of the bonds (interest earned) in the year of death up to the date of death must be reported on the decedent's final return. The transferee (estate or beneficiary) reports on its return only the interest earned after the date of death.
This is a particularly complex point of tax law. You may want to read this blog entry for a more detailed explanation: http://blog.myirstaxrelief.com/2010/02/ird-income-in-respect-of-a-dec.html
