Inherited Real Estate Basis: The Step-Up to Fair Market Value at Date of Death

Basis is what the tax law measures gain against. When property changes hands during life, the buyer's basis is usually cost. When it changes hands at death, the answer changes.

The IRS states the inheritance rule directly: "Generally, the basis of property inherited from a decedent is one of the following. The FMV of the property at the date of the individual's death."^[1] The result is that the years of appreciation the decedent held, sometimes decades of it in South Florida real estate, are erased from the heir's taxable gain when the property is later sold. That single line of the Internal Revenue Code, Section 1014, is one of the most valuable planning provisions in the federal system for a family whose main asset is a house or a rental building. Our advisory solutions engagement is where these date-of-death numbers get pinned down before a later sale forces the answer.

Two dates are on the table. The default is the decedent's date of death. The second choice is what the IRS calls the alternate valuation date: "The FMV on the alternate valuation date if the personal representative for the estate chooses to use alternate valuation."^[1] The instructions for Form 706 describe when the election is available and how it works.

The alternate valuation date is not a general planning lever. It is available when it lowers the total gross estate and the estate tax, and the election, once made, binds every asset in the estate rather than a single lucky one. A rental building that dropped in value in the six months after a death can, in an estate that owes federal estate tax, reduce both the estate tax and the heir's basis to that later figure. In an estate that owes no federal estate tax at all, the alternate valuation date is not a way to increase a beneficiary's basis; the personal representative cannot elect it just to raise the heir's number. Where the executor's mechanics are getting settled, our individual tax return preparation service coordinates the estate-tax value with the beneficiary's later return.

How the property was titled the day before the death decides how much of it steps up. The IRS keeps two spouse-and-non-spouse tracks separate.

For property held by joint tenants with right of survivorship who are not married, only the portion includible in the decedent's estate steps up. In the IRS example, John and Jim bought business property for $30,000 with John funding two-thirds and Jim funding one-third, and "Depreciation deductions allowed before John's death were $12,000."^[4] At John's death, "the property had an FMV of $60,000, two-thirds of which is includible in John's estate."^[4] The surviving tenant's own portion of the basis, less depreciation allowed to the survivor on that portion, stays in place; only the inherited portion is reset to the includible FMV share.

For spouses who hold as tenants by the entirety or as the only two joint tenants with right of survivorship, one-half of the property is includible in the decedent spouse's estate: "It doesn't matter how much each spouse contributed to the purchase price."^[5] The survivor's basis becomes one-half of the original cost plus one-half of the FMV at death, reduced by depreciation allowed on the survivor's own half.^[5] When a home in real estate + property management tax help passes to a surviving spouse, that is the calculation carrying the eventual sale.

Community property gets its own rule because a married couple in one of nine states is treated as owning the property together. The IRS: "In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), married individuals are each usually considered to own half the community property. When either spouse dies, the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property."^[3] The condition attached is important: "at least half the value of the community property interest must be includible in the decedent's gross estate, whether or not the estate must file a return."^[3]

The practical result is that a couple who lived in Texas or California and held real estate as community property sees the whole basis reset when the first spouse dies, not just the deceased spouse's half. Florida is not on the list. That matters for a household that moved from California to Florida late in life, because the community character of that property does not automatically disappear at the state line; whether the double step-up survives depends on how the property was held and re-titled. The IRS example makes the math concrete: an $80,000-basis community-property interest whose FMV climbed to $100,000 gives "The basis of your half of the property after the death of your spouse is $50,000 (half of the $100,000 FMV)."^[3]

There is one anti-abuse rule that cancels the step-up. The IRS states it: "The above rule doesn't apply to appreciated property you receive from a decedent if you or your spouse originally gave the property to the decedent within 1 year before the decedent's death. Your basis in this property is the same as the decedent's adjusted basis in the property immediately before their death, rather than its FMV. Appreciated property is any property whose FMV on the day it was given to the decedent is more than its adjusted basis."^[2]

The rule is aimed at deathbed transfers designed to manufacture a basis reset. If a taxpayer gifts a highly appreciated rental to a terminally ill relative and inherits the same property back within a year, the basis stays at the decedent's number. The 1-year window is measured to the day. This is a case where an the federal estate tax exemption at $15 million conversation, done well in advance, is the difference between a plan that works and one that the IRS strips out on audit.

For inherited rental real estate, the depreciation history restarts on the inherited portion. The IRS: "If a beneficiary can depreciate inherited property, the Modified Accelerated Cost Recovery System (MACRS) must be used to determine depreciation."^[8] For property that was already partly owned by the surviving tenant, the IRS layers two computations: "The first computation is for the original basis in the property. The second computation is for the inherited part of the property."^[8] The survivor keeps depreciating the original half under the same method used in prior years, and the inherited half is depreciated under MACRS.^[8]

The practical point is that unrecaptured depreciation on the decedent's portion does not follow the property into the heir's hands. The stepped-up basis is what the heir depreciates against and, eventually, sells against. Depreciation the decedent claimed during life does not resurface as recapture income on the heir's later sale. On a property that the heir intends to keep as a rental, the individual tax return preparation workpaper carrying the new depreciable basis is what protects the numbers on every return going forward.

The stepped-up basis rule turns on the US income tax definition of inherited property, not on where the property sits. A US person who inherits real property in Mexico, Colombia, Venezuela, Argentina or any other country still takes a basis equal to the FMV of the property at the date of the individual's death, as the IRS rule states.^[1] The later sale, if it produces a gain, is a US capital gain reported on the heir's US return.

That is only the income-tax side. A US person who receives more than a threshold amount from a foreign estate has a separate reporting requirement, a foreign bank account inherited alongside the property can pull the heir into additional filings, and the country where the property sits will have its own inheritance or transfer tax, sometimes based on the notarized escritura value rather than on the market value the IRS wants. A qualified appraisal that pins the FMV in US dollars on the date of death, using an accepted exchange rate, is the single most valuable piece of paperwork the heir can obtain, because the estate abroad rarely produces it in the form a later IRS review will accept. For clients whose family assets sit in more than one country, our advisory solutions work is the place these cross-border basis questions get settled.

The IRS defines a specific paper trail. When an estate is required to file a federal estate tax return, "the estate beneficiaries generally will receive a Schedule A (Form 8971) from the executor of the estate reporting the estate tax value of property distributed to them. Certain beneficiaries are required to use this value as the initial basis in the property received from the estate."^[7] That consistent-basis rule comes from Section 1014(f), which "requires that basis of certain property acquired from a decedent be consistent with the value of the property as finally determined for estate tax purposes."^[6] The final regulations under that section are T.D. 9991.^[6]

When no estate tax return is filed, the IRS accepts an appraised value used for state inheritance or transmission tax purposes as the source of basis.^[1] The exposure to avoid is a valuation misstatement on the later income tax return: "If the value or adjusted basis of any property claimed on an income tax return is 150% or more of the amount determined to be the correct amount, there is a substantial valuation misstatement."^[9] At 200% it becomes a gross valuation misstatement.^[9] An understatement that produces "an underpayment of tax of more than $5,000" pulls a 20% addition to tax, and a gross misstatement pushes that to 40%.^[9] A qualified appraisal contemporaneous with the date of death is what defends the basis at a later exam.

Holding period is not a question with inherited property. The IRS: "If you sell or dispose of inherited property that is a capital asset, the gain or loss is considered long term, regardless of how long you held the property."^[10] An inherited home sold six weeks after the funeral is still taxed at long-term capital gain rates, computed against the stepped-up basis established on the date of death.

That combination is what makes the step-up so valuable. A property acquired by the decedent decades ago for a modest number becomes a property with a new basis at FMV, taxed on any post-death appreciation at the long-term rate, and the years the decedent held it do not create ordinary-income exposure for the heir. The consistent-basis rule at Section 1014(f) is what keeps the number reported at sale in line with the value the estate used.^[6] The heir's basis then evolves normally from that point forward: it goes up with improvements to the property and down with allowed depreciation and casualty insurance reimbursements.