Step-Up in Basis at Death: What It Means for Rental Property
When a rental owner dies, the property's basis generally resets to its fair market value on the date of death (IRC §1014(a)). The appreciation and the depreciation the owner took over the years are not taxed to the heirs. If they sell soon after, there is usually little or no gain. If they keep renting, they start a new depreciation schedule on the stepped-up value. That is why "hold until death" is one of the most powerful and most misunderstood rental strategies.
The step-up has limits. It depends on how title is held, it does not reach installment notes, it can wipe out suspended passive losses, and gifts during life do not get it. This guide covers each, with a worked example.
How the step-up works
Basis is the number your gain is measured from. For a rental you bought, basis starts at cost and goes down every year by the depreciation you claim. After 25 years, a building can be fully depreciated, so a sale produces gain on both the appreciation and every dollar of depreciation.
At death, §1014(a) gives the heir a basis equal to fair market value at the date of death (or the alternate valuation date, if the estate elects it). Two consequences:
- The deferred gain disappears. Including gain deferred through earlier 1031 exchanges.
- The depreciation recapture disappears. The unrecaptured §1250 gain (taxed at up to 25% on a sale) and any §1245 recapture on cost-segregated components are not taxed to the heirs.
The step-up applies to the property's full value, not just the owner's equity. A mortgage does not reduce it. That follows from Crane v. Commissioner, 331 U.S. 1 (1947). For a full explanation of what the step-up erases, see depreciation recapture explained.
How title changes the step-up
| How the rental is held | What steps up at the first spouse's death |
|---|---|
| Owned by the decedent alone (or a revocable living trust) | The whole property |
| Community property (California and other community property states) | Generally both halves, the decedent's and the survivor's, if at least half of the community interest is included in the decedent's gross estate (§1014(b)(6)) |
| Spouses as joint tenants or tenants by the entirety | Generally only the decedent's half, because only half is included in the estate (§2040(b)) |
| LLC or partnership interest | The interest steps up; the entity's own basis in the building does not change unless a §754 election or similar adjustment applies (a single-member LLC disregarded for tax is treated as owning the building directly) |
| Irrevocable grantor trust not included in the estate | No step-up (Rev. Rul. 2023-2) |
For California couples, the community property rule is a major planning point. How the deed and any trust describe the property matters, so have your estate attorney confirm how title is held.
Worked example: community property vs joint tenancy
Simple example. One rental, federal income tax concepts only, no state tax, no selling costs.
A couple bought a rental in 2000 for $600,000 (building $400,000, land $200,000). They have taken $350,000 of straight-line depreciation. Adjusted basis: $250,000. The first spouse dies when the property is worth $2,400,000. The survivor sells for $2,400,000.
| Community property | Joint tenancy (non-community state) | |
|---|---|---|
| Decedent's half: new basis | $1,200,000 | $1,200,000 |
| Survivor's half: basis | $1,200,000 (also stepped up) | $125,000 (half the old adjusted basis) |
| Total basis at sale | $2,400,000 | $1,325,000 |
| Gain on a $2,400,000 sale | $0 | $1,075,000 |
| Of which unrecaptured §1250 (25% max) | $0 | $175,000 (the survivor's half of the depreciation) |
For comparison, if the couple had sold during life, the gain would have been $2,150,000, including $350,000 of unrecaptured §1250 gain taxed at up to 25%. In this example the step-up does more than a deferral technique could, because the tax is not deferred. It is gone.
Depreciation after inheriting
An heir who keeps renting the property depreciates it again, starting from the stepped-up basis of the building. Land is still not depreciable, so the heir allocates the date-of-death value between land and building.
Simple example. If $1,440,000 of the $2,400,000 value is building, a residential rental's new straight-line depreciation is about $1,440,000 / 27.5 years, roughly $52,364 a year before the first-year convention. That new depreciation is recaptured when the heir eventually sells.
Inherited property is not "purchased" for bonus depreciation purposes (§179(d)(2)(C)(ii), applied through §168(k)(2)(E)(i)), so cost-segregated components of an inherited building do not qualify for bonus. They still start a fresh MACRS schedule.
Selling an inherited rental
Because the basis is the date-of-death value, a sale soon after death usually produces little gain or loss. The gain or loss is measured from the stepped-up basis, adjusted for any depreciation the heir takes and any improvements. An appraisal as of the date of death is the key document. Get one even if no estate tax is due, because it sets your basis.
If you inherit and plan to sell, the timeline is yours. There is no requirement to sell within a set period. If you keep it as a rental, it is a new rental activity for you under the passive loss rules.
What the step-up does not cover
Suspended passive losses. At death, the owner's suspended passive losses on the property are deductible on the final return only to the extent they exceed the step-up in basis (§469(g)(2)). In the example above, the step-up on the decedent's half alone is $1,075,000. Unless the suspended losses are larger than that, they are lost. Owners with large Form 8582 carryovers should look at using them during life. See what happens to suspended passive losses when property is sold.
Installment notes. If the owner sold the property on an installment note before death, the remaining payments are income in respect of a decedent. There is no step-up; the heirs report the gain as they are paid (§§691(a)(4), 1014(c)), with a possible §691(c) deduction for federal estate tax attributable to the note. See installment notes at death.
Gifts during life. Property given away while the owner is alive generally keeps the owner's basis, so the recipient inherits the built-in gain and depreciation. Giving a low-basis rental to children often costs the family the step-up.
Estate tax. The step-up is an income tax rule. Estate tax is separate. The federal basic exclusion amount is $15,000,000 per person for 2026. Most rental owners will not owe federal estate tax, but large portfolios should plan for it.
Will the step-up survive?
Repeal of the step-up has been proposed before. The 2025 tax law (P.L. 119-21) did not change §1014. That is not a promise about future law, and any plan that depends on dying with the property should be reviewed as rules change. The recent changes and what could come next are covered in tax law changes for real estate sellers.
Hold until death vs sell now
Holding until death gives the family the step-up, but it means living with the property, the tenants and the concentration risk. Many owners borrow against the property instead of selling, or 1031 exchange until death. Those strategies, and when an installment sale beats them, are compared in swap till you drop vs an installment sale.
Bottom line
The step-up in basis resets an inherited rental to fair market value and erases the built-in gain and depreciation recapture, often the largest tax on a long-held property. How title is held decides whether one half or both halves step up, and community property is a major advantage. The step-up does not reach installment notes, it can erase suspended passive losses, and lifetime gifts do not get it. If you are weighing selling now against holding, run the sale in the calculator and read the free book on timing a sale against your losses.
Questions to ask your CPA
- How is title to each rental held, and would both halves step up at the first death?
- What is my adjusted basis today, and how much gain and recapture would a sale during life trigger?
- How large are my suspended passive losses, and would they be lost at death under §469(g)(2)?
- If I sell on an installment note, what happens to the unpaid balance if I die?
- Should we get a date-of-death appraisal, and how should value be split between land and building?
- Are any properties in an irrevocable trust or LLC where the step-up may not reach the building?
- Is estate tax a factor for us under the current exclusion amount?
Get the full playbook. The Waterfall Strategy, the 20-minute version and the one-page Cliff Notes, free.
Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.