A Real Estate Investor’s Guide to the Step-Up in Basis
For many investment property owners, long-term growth potential and legacy planning go hand in hand. While income generation is a common goal, asset transfer considerations may also play a role in investment decisions. One relevant tax provision in this context is the step-up in basis, a rule under U.S. tax law that adjusts the tax basis of inherited property to its fair market value at the time of the original owner's death.
This adjustment can reduce or eliminate capital gains taxes on appreciation that occurred prior to inheritance when the property is eventually sold by the heir. Understanding how the step-up in basis works is an important element of tax and estate planning for those managing real estate assets.
What Is the Step-Up in Basis?
When a person inherits real estate (or other capital assets), the IRS allows for a step-up in the cost basis to the asset’s fair market value (FMV) at the date of the original owner’s death. This adjustment is known as a step-up in basis and serves to limit the capital gains tax liability for heirs.
Let’s say an investor purchased a rental property in 1990 for $200,000. By 2025, the property is worth $900,000. If the investor sold the property before passing away, they would owe capital gains tax on $700,000 in gains (adjusted for depreciation). However, if the property is inherited, the heir receives a stepped-up basis of $900,000, eliminating the prior unrealized gain from tax consideration.
If the heir sells the property for close to its inherited FMV, the capital gain—and resulting tax—is minimal or even zero.
Policy Debate Around the Step-Up in Basis
The step-up in basis provision allows unrealized capital gains to go untaxed at death, which has drawn scrutiny from some policymakers and commentators. Critics argue that this treatment provides a tax-free reset of asset values across generations, favoring wealth accumulation without a corresponding tax event.
However, from a tax compliance and estate planning perspective, the step-up in basis is a lawful and long-standing mechanism under the Internal Revenue Code. It is widely used, particularly in real estate and investment planning, to align asset valuation with fair market conditions at the time of inheritance.
How This Impacts Investment Property Owners
Real estate often appreciates over long periods, and investment properties may accumulate additional gain through improvements and inflation. The eventual taxable gain at sale can be significant when combined with depreciation deductions, which lower the cost basis over time. However, by holding appreciated property until death, owners may allow heirs to:
- Avoid capital gains on historic appreciation
- Sell shortly after inheriting with little or no tax liability
- Potentially restructure the portfolio for diversification or income
Important Considerations
When it comes to the step-up in basis, there are several key factors that can affect its applicability and future viability.
- Married couples in community property states may benefit from a full step-up on jointly owned property, unlike common law jurisdictions where only the deceased spouse’s share receives a step-up.
- Trusts and estate planning tools may preserve step-up benefits if appropriately structured.
- Policy proposals to eliminate or limit the step-up have surfaced but remain politically uncertain.
Final Thoughts
The step-up in basis is a well-established provision of the U.S. tax code that can provide meaningful tax benefits for real estate investors focused on long-term planning.If your investment goals include legacy planning, understanding and leveraging the step-up in basis can help maximize the after-tax value passed to heirs.
Before making decisions, consult an estate planning attorney or tax advisor to ensure your strategy aligns with your goals and the latest tax regulations.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
