Selling Inherited Rental Property: Step-Up Basis, Taxes, and Whether a 1031 Makes Sense

How the stepped-up basis works

When you inherit real estate, your basis is the property's fair market value on the date of death (or the alternate valuation date six months later if the executor elects it). Your parent's original purchase price, their improvements, and every dollar of depreciation they claimed are irrelevant. If they bought a building for $150,000 in 1990 and it's worth $1.4 million when they pass, your basis is $1.4 million.

This applies whether the property was held outright, in a revocable living trust, or through a chain of 1031 exchanges going back decades. The deferred gain is not 'due' at death; it's eliminated. That's the endgame of swap till you drop.

When you sell right away

Sell within a year or so of death at roughly appraised value and your gain is the difference between the net sale price and the stepped-up basis: typically near zero, and often a small loss once commissions and closing costs are subtracted. Inherited property is treated as held long-term regardless of how long you actually hold it (IRC §1223(9)), so any gain gets long-term rates.

Get a qualified appraisal as of the date of death, even if the estate was too small to file an estate tax return. That appraisal is your basis documentation for the rest of your life.

When you still owe tax

• Appreciation after death. Hold the rental for five years and it goes up $300,000: that gain is yours and fully taxable at sale, along with the depreciation you've claimed since inheriting.
• Joint ownership with the deceased. If you co-owned the property, only the deceased's share steps up (with a favorable exception for community property in community-property states, where both halves step up).
• Property gifted before death. Gifts carry over the donor's basis. A parent who deeds the rental to you while alive hands you their low basis and their recapture. This is the single most common estate-planning mistake I see with rental property.
• Inherited from a partnership or LLC. You inherit the entity interest, and the inside basis of the property only steps up if the entity makes a §754 election. Ask the CPA.

Does a 1031 exchange make sense on inherited property?

Not if you're selling immediately: there's no gain to defer. It makes a great deal of sense in two scenarios.

Scenario 1: you've held it and it's appreciated. The property is investment real estate in your hands, so it qualifies for §1031 like any other. The stepped-up basis means your gain is measured only from the date of death, and you defer it by exchanging.

Scenario 2: you want out of management, not out of real estate. Heirs frequently inherit a building they have no interest in running, in a city they don't live in. An exchange into a Delaware Statutory Trust or into rentals near you keeps the deferral going without the landlord job. The DSTs I work with are zero-cash-flow structures, which suits heirs who want the equity preserved rather than a monthly check.

Practical checklist for heirs

1. Order a date-of-death appraisal before anything else.
2. Confirm how title passed: probate, trust, joint tenancy, or transfer-on-death deed. This affects the step-up and your ability to sell.
3. Restart depreciation from the stepped-up basis (building portion only) on your own return.
4. Decide whether you're a seller or an investor. Sellers close quickly and owe little. Investors should treat the property like any rental and plan an exchange when the time comes.
5. If siblings inherited together and want different things, plan the split before listing. Co-owners can each run their own exchange, but the structure matters; see drop-and-swap exchanges.