Inherited Property Basis After Death: Step Up in Basis, Appraisals, and Sale Tax Rules
When property passes at death, its income tax basis often changes substantially.
Internal Revenue Code Section 1014 generally gives property acquired from a decedent a basis equal to its fair market value on the date of death. This is commonly called a step up in basis because appreciated property often receives a higher basis.
But the rule is more accurately described as a basis adjustment at death.
The basis determination can directly affect capital gain or loss, depreciation on inherited rental property, California income tax reporting, and the records a beneficiary should retain.
What Is the Basis of Property Inherited at Death?
Internal Revenue Code Section 1014(a) provides the general rule.
Property acquired from a decedent or passing from a decedent generally receives a basis equal to:
- Fair market value on the date of death
- The value on the applicable alternate valuation date if a valid Section 2032 election is made
- Special use value when Section 2032A applies
- Another basis specifically required by Section 1014 for particular property
Example: Appreciated Property
Assume a parent purchased a home decades ago for $150,000 and made $50,000 of capital improvements.
The parent's adjusted basis immediately before death is $200,000.
The property is worth $700,000 on the date of death.
If the property qualifies for the general Section 1014 rule, the beneficiary's basis is generally $700,000.
The $500,000 of appreciation occurring before death generally is not built into the beneficiary's later capital gain calculation.
A Basis Adjustment Can Also Be a Step Down
If property has an adjusted basis of $700,000 immediately before death but is worth only $550,000 when the owner dies, the new basis under the general Section 1014 rule is generally $550,000.
The unrealized economic loss that existed before death does not simply transfer to the beneficiary.
What Property Is Considered Acquired From a Decedent?
Section 1014(b) defines several categories of property treated as acquired from or passing from a decedent.
The rules can include property received through:
- A will
- Intestate inheritance
- A decedent's estate
- Certain revocable trusts
- Certain trusts in which the decedent retained powers affecting enjoyment
- Certain powers of appointment
- Community property
- Property otherwise included in the decedent's gross estate under specified estate tax provisions
Probate is therefore not a requirement for a Section 1014 basis adjustment.
Does Property in a Revocable Living Trust Receive a Basis Adjustment?
Commonly, yes.
Property does not lose Section 1014 treatment merely because it was held in a revocable living trust and avoided probate.
Section 1014 specifically includes certain trust property when the decedent retained the power to revoke the trust or retained specified powers to alter, amend, or terminate enjoyment.
Not every irrevocable trust receives a new basis merely because the grantor dies, so the trust terms and retained powers should be reviewed.
Do You Need a Date of Death Appraisal?
Section 1014 determines basis from fair market value. It does not state that every inherited asset must have a formal appraisal.
The practical issue is substantiation.
For real estate and other assets without a readily observable market price, a retrospective appraisal as of the date of death can provide strong evidence of fair market value.
A date of death valuation can be particularly important for:
- Residential real estate
- Rental properties
- Commercial buildings
- Farms and ranches
- Closely held businesses
- Partnership and LLC interests
- Valuable collectibles
- Other property without a public market price
Publicly Traded Securities
Stocks and other publicly traded securities generally can be valued using the applicable estate tax valuation rules based on market quotations on the valuation date.
What Does Fair Market Value Mean?
For federal estate tax purposes, fair market value generally means the price at which property would change hands between a willing buyer and willing seller when neither is under a compulsion to buy or sell and both have reasonable knowledge of relevant facts.
The correct basis is not necessarily the county property tax assessment, the decedent's purchase price, the mortgage balance, or an automated real estate estimate.
What If the Property Is Sold Soon After Death?
A sale shortly after death can sometimes produce only a modest taxable gain because inherited basis may be close to the property's sale value.
But a quick sale does not automatically mean there is no gain.
Sale Example
Assume inherited property has a supportable date of death basis of $600,000.
The beneficiary later sells it for $650,000 and incurs $30,000 of selling expenses that reduce the amount realized.
Sale price: $650,000
Less selling expenses: $30,000
Amount realized: $620,000
Less adjusted basis: $600,000
Capital gain: $20,000
Is the Sale of Inherited Property Long Term?
If inherited property is a capital asset, gain or loss on its sale is generally treated as long term regardless of how long the beneficiary actually held it.
A beneficiary who inherits stock and sells it two months later therefore generally receives long term rather than short term capital gain or loss treatment.
Can a Loss on Inherited Property Be Deducted?
It depends on how the property is held.
A loss on property held for personal use generally is not deductible.
A loss on property held in a trade, business, or transaction entered into for profit can receive different treatment.
What Happens When an Executor Elects Alternate Valuation?
Section 2032 allows an executor to elect alternate valuation when the statutory requirements are satisfied.
The election generally must reduce both:
- The value of the gross estate
- The combined estate and generation skipping transfer tax payable, after allowable credits
If elected, property disposed of within six months after death generally is valued on the earlier transaction date, while property still held generally is valued six months after death.
The election applies to the estate as a whole rather than asset by asset.
Because Section 1014 uses the alternate valuation when a valid Section 2032 election applies, inherited basis can also change.
California Community Property Can Receive a Full Basis Adjustment
Community property creates an especially important basis rule for married couples in California.
Section 1014(b)(6) provides that the surviving spouse's one half share of qualifying community property is also treated as property acquired from the decedent if at least one half of the entire community property interest was includible in the decedent's gross estate.
As a result, both halves of qualifying community property can receive a basis adjustment at the first spouse's death.
California Community Property Example
Assume spouses own qualifying California community property with an adjusted basis of $200,000.
The property's fair market value when one spouse dies is $1,000,000.
Assuming Section 1014(b)(6) applies, both spouses' interests generally receive the applicable date of death basis adjustment.
The combined basis can therefore become approximately $1,000,000.
Joint Tenancy Is Not the Same as Community Property
For a qualified joint interest held only by spouses as joint tenants with right of survivorship or tenants by the entirety, Section 2040(b) generally includes one half of the property in the deceased spouse's gross estate.
The inherited portion generally receives the Section 1014 adjustment, while the surviving spouse's existing portion generally retains its own adjusted basis.
Joint Tenancy Example
Assume spouses own property as joint tenants rather than qualifying community property.
Adjusted basis before death: $200,000
Fair market value at death: $1,000,000
Ignoring other adjustments, the surviving spouse may have:
Existing basis in survivor's one half: $100,000
Basis of inherited one half: $500,000
Total basis after death: approximately $600,000
Joint Ownership With Someone Other Than a Spouse Is More Complicated
For joint property owned with someone other than a spouse, Section 2040 generally uses a contribution based rule.
The portion included in the decedent's estate can depend on who originally supplied the consideration used to acquire the property.
The surviving owner's basis therefore is not automatically determined by a 50 percent adjustment.
What Happens to an Inherited Rental Property?
If inherited rental property qualifies under Section 1014, the beneficiary generally starts with the inherited basis determined under the applicable valuation rule.
The basis must then be allocated between land and depreciable improvements.
Inherited Rental Property Example
Assume a beneficiary inherits residential rental property worth $700,000.
A supportable allocation establishes:
Land: $175,000
Building: $525,000
If the beneficiary continues to hold the property for rental use and the property is ready and available for rent, the building's inherited basis generally becomes the starting point for the beneficiary's depreciation calculation, subject to applicable adjustments.
Residential rental property under the general depreciation system is generally depreciated using the straight line method over 27.5 years with the mid month convention.
Joint Rental Property Requires Additional Care
If a surviving joint owner already owned part of the property before death, the preexisting share and inherited share can require separate depreciation calculations.
Does the Decedent's Prior Depreciation Carry Over?
For property receiving a new Section 1014 basis, the beneficiary does not simply continue the decedent's old adjusted basis after years of depreciation.
The death basis rules first determine the beneficiary's basis. Depreciation and other adjustments occurring during the beneficiary's own period of ownership then affect that basis.
Special rules can apply to joint interests, entities, and assets that do not qualify for Section 1014.
What If the Beneficiary Inherits a Partnership or LLC Interest?
Section 1014 can generally determine the beneficiary's outside basis in an inherited partnership interest.
That does not automatically adjust the partnership's basis in the underlying assets.
A separate inside basis adjustment can depend on Sections 743 and 754 and other partnership basis rules.
Income in Respect of a Decedent Does Not Receive the Normal Basis Adjustment
Section 1014(c) excludes rights to receive income in respect of a decedent, commonly called IRD, from the normal Section 1014 basis adjustment.
Potential examples include:
- Certain traditional IRA and retirement plan benefits
- Unpaid compensation earned before death
- Accrued interest
- Accounts receivable of a cash basis taxpayer
- Certain installment sale obligations and payments
- Other income earned or economically accrued before death but not included in the decedent's income before death
Inherited IRA Example
A traditional IRA does not simply receive a fair market value basis adjustment under Section 1014 that makes all future distributions tax free.
The income tax rules governing retirement distributions continue to apply.
Property Given to the Decedent Shortly Before Death Can Lose the Basis Adjustment
Section 1014(e) contains an anti abuse rule.
If appreciated property is given to a decedent during the one year period ending on the date of death and the property then passes back to the original donor or the donor's spouse, the normal fair market value basis generally does not apply.
The basis generally remains the decedent's adjusted basis immediately before death.
Gifted Property and Inherited Property Have Very Different Basis Rules
A lifetime gift generally does not receive the same basis treatment as inherited property.
Under Section 1015, property received by gift generally carries over the donor's adjusted basis for determining gain, subject to special rules including the loss basis rule when fair market value at the date of gift is below the donor's basis.
Gift Versus Inheritance Example
Assume a parent owns real estate with:
Adjusted basis: $100,000
Fair market value: $700,000
Lifetime gift: The child's basis for gain generally begins with the parent's approximately $100,000 carryover basis, subject to applicable adjustments.
Inheritance: If Section 1014 applies and the date of death value is $700,000, the child's basis generally becomes $700,000.
The income tax basis result is only one factor in deciding whether property should be transferred during life.
Proposition 19 Does Not Determine Income Tax Basis
California Proposition 19 and Section 1014 answer different questions.
Section 1014 addresses income tax basis.
Proposition 19 addresses California property tax reassessment and base year value rules for certain real estate transfers.
A beneficiary can receive an income tax basis adjustment at death while separately facing a California property tax reassessment.
For the California property tax rules, see California Proposition 19 and inherited homes.
California Income Tax Basis Generally Also Starts With Date of Death Value
For California income tax purposes, inherited property generally receives a basis based on fair market value at death.
California basis can nevertheless differ from federal basis because California has not conformed to every federal depreciation, credit, expensing, and basis adjustment rule.
Federal and California adjusted basis should therefore be tracked separately when differences exist.
Basis Consistency and Form 8971
Internal Revenue Code Sections 1014(f) and 6035 establish federal estate tax basis consistency and information reporting rules for specified property and estates.
Final Treasury regulations effective in 2024 provide detailed rules for these requirements.
What Is Form 8971?
Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, is used by certain executors required to file Form 706 or Form 706 NA under Section 6018.
The executor files Form 8971 with the IRS and provides beneficiary specific Schedule A information when required.
Form 8971 Does Not Apply to Every Estate
Current IRS instructions provide that Form 8971 generally is not required when, among other situations, the estate is below the Section 6018 filing requirement or Form 706 is filed solely to elect portability.
The general Section 1014 basis rule can apply even when no Form 706 or Form 8971 is required.
When Does the Consistent Basis Rule Limit a Beneficiary?
Section 1014(f) provides that certain property subject to the consistent basis requirement cannot have an initial basis greater than its final value for federal estate tax purposes.
The final regulations limit this rule to specified consistent basis property.
In general, the statutory limitation applies when inclusion of the property in the estate increased federal estate tax liability after applicable credits.
Later legitimate basis adjustments, such as capital improvements or depreciation after inheritance, can still increase or decrease adjusted basis.
What Records Should an Inheritor Keep?
- Date of death appraisal
- Estate tax return schedules
- Form 8971 Schedule A, if applicable
- Trust documents
- Will and probate records
- Recorded deeds
- Brokerage valuation statements
- Partnership or LLC valuation reports
- Evidence of community property status
- Joint ownership contribution records
- Improvement records
- Depreciation schedules
- Closing statements from a later sale
- Selling expense documentation
A date of death valuation should be retained even if the beneficiary does not expect to sell the property immediately.
What If an Estate or Trust Distributes Property Later?
The initial basis acquired at death and the basis after a later fiduciary distribution are related but not always identical questions.
Section 643(e) contains separate rules governing the basis and potential gain or loss consequences of certain property distributions by an estate or trust.
For additional discussion, see trust distributions and beneficiary taxation.
Frequently Asked Questions
Does all inherited property get a step up in basis?
No. Most qualifying property acquired from a decedent receives a basis determined under Section 1014, but exceptions exist. The adjustment can also be downward.
Do I need an appraisal when I inherit a house?
A formal appraisal is not universally required by Section 1014, but the beneficiary must be able to substantiate fair market value. A retrospective date of death appraisal can provide strong support for real estate basis.
Does a house in a revocable living trust receive a step up in basis?
Commonly, yes. Avoiding probate does not by itself prevent a Section 1014 basis adjustment.
Does a surviving spouse in California receive a full basis adjustment?
For qualifying community property, both the deceased spouse's half and surviving spouse's half can receive the Section 1014(b)(6) basis adjustment.
Does joint tenancy always receive a 50 percent basis adjustment?
No. Spousal qualified joint interests and nonspousal joint interests are governed by different estate inclusion rules, and community property has its own rule.
Is inherited property always treated as long term when sold?
Inherited property that is a capital asset generally receives long term capital gain or loss treatment regardless of the actual holding period.
Does an inherited IRA receive a step up in basis?
Not under the ordinary Section 1014 rule. Income in respect of a decedent is excluded from the normal basis adjustment.
Does inherited rental property start a new depreciation calculation?
Generally, depreciation of the inherited portion is determined using its inherited basis and the depreciation rules applying to the beneficiary. Joint ownership and other special situations can require separate computations.
Is it better to inherit appreciated property than receive it as a lifetime gift?
Inheritance can produce a higher income tax basis than a lifetime gift because gifts generally use carryover basis while inherited property commonly uses fair market value. Other estate planning considerations may outweigh the basis result.
Does Proposition 19 change inherited income tax basis?
No. Proposition 19 governs California property tax reassessment. Section 1014 and related rules govern federal inherited basis.
Do I need Form 8971 to claim inherited basis?
Not necessarily. Form 8971 applies only in specified estate tax reporting circumstances. Section 1014 can apply even when no Form 706 or Form 8971 is required.
Establish Basis Before the Property Is Sold
The tax consequences of inherited property often depend on records created shortly after death.
Determining and documenting date of death value, ownership structure, community property status, land and building allocation, and other basis information during administration can prevent substantial uncertainty years later.
Estate, Trust and Inheritance Tax ServicesFinal Takeaway
Inherited property does not simply carry forward the decedent's old tax basis.
For qualifying property, Section 1014 generally replaces that basis with fair market value at death or another value required by the estate tax valuation rules.
Community property can receive an adjustment to both spouses' interests. Joint tenancy may receive only a partial adjustment. Rental property requires a new depreciation analysis. Income in respect of a decedent does not receive the normal Section 1014 adjustment. Lifetime gifts generally follow carryover basis rules. Certain large estates also must coordinate basis with Form 8971 and the federal consistency rules.
For inherited real estate and other substantial assets, determining fair market value and preserving the supporting records shortly after death is often one of the most important tax steps a beneficiary can take.
