How the step-up works
Under IRC Section 1014, property inherited from a decedent takes a basis equal to its fair market value on the date of death (or an alternate valuation date). For rental property this is transformative: the decedent may have claimed hundreds of thousands of dollars in depreciation during their lifetime, reducing the adjusted basis far below what the property is worth.
The heir's basis is reset to FMV regardless of what the decedent paid or how much depreciation they claimed. Neither the depreciation deductions nor the embedded capital gain passes to the heir. It is a clean slate.
What disappears at the step-up
Two major tax costs are eliminated when rental property is inherited at stepped-up basis. First, depreciation recapture: the section 1250 unrecaptured gain that would be taxed at up to 25% on sale disappears because the new basis equals FMV, leaving no embedded gain. Second, long-term capital gain: any appreciation the decedent experienced during their ownership is permanently excluded — the heir's gain is measured from the new FMV basis, not the decedent's original cost.
Example: A rental purchased for $200,000, depreciated to an adjusted basis of $120,000, and worth $500,000 at death. The heir's basis is $500,000 — zero embedded recapture, zero gain inherited from the decedent's ownership period.
Planning around the step-up
The "swap till you drop" strategy — continuing 1031 exchanges throughout life and holding the final property until death — leverages the step-up to eliminate taxes that compound through a lifetime of deferrals. It is one of the most powerful tax strategies available to real estate investors.
The estate may still owe federal estate tax if the estate exceeds the applicable exclusion amount (approximately $13.99 million per person in 2025). The step-up eliminates income tax on the appreciation but does not reduce estate tax. For large estates, planning should consider both.
Frequently asked questions
Do heirs owe depreciation recapture on inherited rentals?
No. The step-up in basis resets to fair market value, eliminating embedded depreciation. The heir can then start fresh depreciation from the new stepped-up basis.
Can an heir depreciate an inherited rental?
Yes. The heir gets a new basis equal to FMV at date of death and begins a new depreciation schedule from that amount, allocated between land and building.
Does the step-up apply to property held in a trust?
Property in a revocable living trust typically receives a step-up. Property in an irrevocable trust generally does not, because it is not included in the gross estate. The structure matters greatly — consult an estate planning attorney.
Sources
- IRS Topic No. 409 — Capital Gains and Losses
- IRS Publication 544 — Sales and Other Dispositions of Assets
- IRS Publication 946 — How to Depreciate Property
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.