Step-Up in Basis at Death of Spouse: Rental Property Rules

When a spouse dies, the rental property they owned (or co-owned) gets a new tax basis equal to its fair market value on the date of death. This is the step-up in basis at the death of a spouse, and for rental property it does three things at once: it wipes out built-in capital gain that had accumulated during the marriage, it erases the depreciation recapture that would have been owed on a lifetime sale, and it lets the surviving spouse start a fresh depreciation schedule on the higher value. How much of the property gets the reset depends on the state you live in.

How Much of the Property Steps Up

Federal law treats inherited property as taking a basis equal to its fair market value on the date of death, rather than carrying over the decedent’s adjusted basis.¹ For a rental that has been depreciated for years, the effect is large. A property bought for $200,000, depreciated down to a $120,000 adjusted basis, and worth $500,000 at death gets a new basis of $500,000. Both the appreciation and the accumulated depreciation drop out of the tax ledger.

The share of the property that steps up depends on state property law.

Common Law States

In common law states (every state except the nine listed below), only the deceased spouse’s share of the property is stepped up. If the couple owned the rental jointly at 50/50, the survivor’s half keeps its original adjusted basis and the deceased spouse’s half resets to fair market value. On a property bought for $200,000 and worth $800,000 at death, the survivor’s half stays at $100,000, the decedent’s half steps up to $400,000, and the new combined basis is $500,000.

Community Property States

The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.² In these states, when one spouse dies the entire property steps up, including the surviving spouse’s half, as long as at least half the community interest was includible in the decedent’s gross estate.¹ Using the same $200,000 purchase and $800,000 value, the entire property resets to $800,000. This “double step-up” can eliminate the built-in gain entirely.

Splitting the New Basis Between Land and Building

Land is not depreciable, so before the depreciation clock can restart, the stepped-up value has to be allocated between the land and the building. The IRS method is to multiply the total basis by a fraction: the fair market value of each component over the fair market value of the whole property.³ If a property appraised at $500,000 has land worth $125,000 and a building worth $375,000, then 75% of the new basis is depreciable and 25% is not.

When precise values are uncertain, the IRS permits using assessed values from the local property tax rolls to make the split. Getting this right matters because the allocation flows through every year of depreciation for the next 27.5 years. Most appraisers can provide a separate land and improvement value in the same report used to establish the date-of-death value.

Restarting Depreciation on the New Basis

Residential rental property depreciates over 27.5 years under the general depreciation system.⁴ For the surviving spouse, the clock starts fresh on the date of the spouse’s death, using the building’s share of the stepped-up value as the depreciable amount.

For a property that had been depreciated for many years, this reset usually produces much larger annual deductions than the couple was claiming before. A building whose remaining basis had shrunk to almost nothing suddenly has a fresh depreciable amount based on current market value, and those deductions offset rental income going forward.

Prior Depreciation Recapture and Suspended Losses

The step-up eliminates the depreciation recapture that would have applied on a lifetime sale. Recapture taxes prior depreciation deductions at a rate of up to 25% when a rental is sold. Because the basis resets to fair market value at death, that prior depreciation is no longer built into the basis, and there is nothing to recapture. On a property with $150,000 or more of accumulated depreciation, the tax saved by this feature alone can exceed $35,000.

Suspended passive activity losses are treated differently. Many rental owners accumulate these losses over the years because their income is too high to deduct rental losses currently. When the owner dies, the suspended losses do not simply transfer to the surviving spouse. They are reduced by the amount of the step-up in basis, and only losses exceeding the step-up are deductible on the decedent’s final return.⁵ For an appreciated rental, the step-up almost always exceeds the accumulated losses, so nothing survives. A property with $60,000 in suspended losses and a $200,000 step-up loses all $60,000. With $250,000 in suspended losses and a $200,000 step-up, only $50,000 remains deductible on the final return. It’s worth reviewing this with a tax professional before filing the decedent’s final return.

Selling After the Step-Up

If you decide to sell the rental, the new basis directly reduces the taxable gain. Capital gain is the sale price minus the adjusted basis, and because the basis was reset to fair market value at death, the appreciation that built up during the marriage is not taxed.¹ A sale shortly after death, close to the appraised value, may produce little or no taxable gain.

Inherited property also automatically qualifies for long-term capital gains treatment, no matter how briefly the surviving spouse holds it before selling.⁶ That matters because short-term gains are taxed at ordinary income rates, which are usually higher than long-term capital gains rates.

Documenting the Fair Market Value

The entire benefit of the step-up depends on being able to prove what the property was worth on the date of death. Without documentation, the IRS can treat the basis as zero, which maximizes the taxable gain on a future sale. Getting a qualified appraisal promptly is the single most important step.

A credentialed appraiser evaluates condition, location, and recent comparable sales to arrive at a fair market value as of the specific date of death. That report becomes the supporting document for the new basis on every future tax return. Appraisal fees for a single-family rental typically run $300 to $600, with more for multi-unit properties or when a comparable rent schedule is needed.

Alongside the appraisal, keep:

A certified copy of the death certificate, which establishes the valuation date.
The will, trust, deed, or other transfer documents showing how the property passed to you.
Prior tax records, including old depreciation schedules, improvement receipts, and the original closing statement, in case the IRS compares old basis to new.

When the Step-Up Doesn’t Apply: The One-Year Gift Rule

One anti-abuse rule catches some couples off guard. If the surviving spouse gave appreciated property to the deceased spouse within one year before death, and the property passes back to the surviving spouse (or the estate sells it and the proceeds go to the surviving spouse), no step-up applies. The basis stays at whatever the decedent’s adjusted basis was immediately before death.¹ The rule prevents transferring a low-basis rental to a terminally ill spouse to reset the basis and inherit it back at the higher value.

Alternative Valuation Date

Federal law gives the executor a second option: value the estate as of six months after death instead of the date of death. If the property is sold or distributed during those six months, the value on the sale or distribution date is used.⁷ When the election is made, the inherited basis follows the alternative date.¹ The election is only available if it decreases both the gross estate’s value and the total estate tax liability, and it applies to the entire estate rather than to a single property. That makes it primarily relevant for larger estates that owe estate tax, and it’s a decision for the executor and estate attorney rather than the surviving spouse alone.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
Internal Revenue Service. Publication 555 (12/2024), Community Property
3
Internal Revenue Service. Publication 551, Basis of Assets
4
Internal Revenue Service. Publication 527 (2025), Residential Rental Property – Section: Recovery Periods Under GDS
5
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
6
Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property
7
eCFR. 26 CFR 20.2032-1 – Alternate Valuation