“Real estate cannot be lost or stolen, nor can it be carried away.”
— Franklin D. Roosevelt
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For many real estate investors, the goal extends beyond generating rental income or building equity. A thoughtfully constructed real estate portfolio can become a lasting legacy for children, grandchildren, and future generations. One of the most valuable tax provisions supporting that objective is the step-up in basis.
Under current tax law, inherited property generally receives a new tax basis equal to its fair market value at the owner's death. This adjustment can significantly reduce or eliminate capital gains taxes that would otherwise be due when the property is eventually sold.
For example, assume an investor purchased a rental property for $300,000 and, over time, its value increased to $700,000. Under the step-up in basis rules, the heir receives the property with a new cost basis of $700,000. If the property is sold shortly thereafter for approximately that amount, there would generally be no capital gains tax on the $400,000 of appreciation that occurred during the original owner's lifetime.
For long-term real estate investors, this can be a tremendous wealth preservation opportunity. Rather than inheriting decades of built-in capital gains taxes, heirs often receive a fresh tax basis, allowing appreciated real estate to transfer much more efficiently from one generation to the next.
Step-Up in Basis and the Depreciation Reset
Another significant advantage is that the heir is not required to sell the property. They may continue collecting rental income while benefiting from a new depreciation schedule based on the property's stepped-up value.
Even if the original owner had fully depreciated the property, the heir could generally begin depreciating the stepped-up basis as though the property were newly acquired. This creates another opportunity to benefit from what we discussed in our previous article: the phantom deduction, reducing taxable rental income without requiring additional cash outlays.
In many cases, the combination of the step-up in basis and the depreciation reset eliminates both the accumulated capital gains tax and depreciation recapture tax that otherwise would have been due had the original owner sold the property during their lifetime.
It is important to note, however, that while the step-up in basis may eliminate capital gains and depreciation recapture taxes, it does not eliminate potential estate taxes.
Estate tax planning remains an important part of a comprehensive wealth transfer strategy.
When combined with thoughtful estate planning, the step-up in basis can help preserve family wealth, improve tax efficiency, and support the long-term transfer of real estate across generations. For these reasons, real estate remains one of the most effective tools available for building and transferring generational wealth.
Key Takeaways
- The step-up in basis generally adjusts an inherited property's tax basis to its fair market value at the owner's death.
- Appreciation during the original owner's lifetime may never be subject to capital gains tax.
- Heirs who retain inherited investment property generally receive a new depreciation schedule based on the stepped-up value.
- The combination of the step-up in basis and depreciation reset can significantly reduce or eliminate capital gains and depreciation recapture taxes.
- The step-up in basis does not eliminate potential estate taxes.
This article is part of our Tax-Smart Real Estate Investing series, adapted from the chapter titled “Investing in Real Estate” of our new book, The Generational Wealth Code. In future articles, we will continue exploring the strategies that experienced investors use to build and preserve wealth through real estate.
For a deeper look at how real estate investing and other tax-smart strategies can support your long-term financial goals, we encourage you to order a copy of The Generational Wealth Code today.
This material is for informational purposes only and should not be considered tax or legal advice. You should consult your tax and legal professionals regarding your individual situation. Investing in real estate involves risks, including fluctuations in property values, income variability, and changes in tax laws. There is no guarantee that any strategy will be successful. Depreciation and other tax benefits depend on individual circumstances and current tax law, which may change.
Certain strategies discussed, including cost segregation and Section 1031 exchanges, involve additional risks and complexities and may not be appropriate for all investors.