Inheriting property can feel overwhelming, especially when you're trying to figure out the tax implications. The good news is that you're likely entitled to a significant tax benefit called "stepped-up basis" that could save you thousands of dollars when you eventually sell. Understanding how to determine the cost basis of inherited property is crucial for making informed decisions about your inherited asset.
Whether you've recently inherited a family home, investment property, or business, you need to know your cost basis to calculate potential capital gains taxes accurately. We'll walk you through the entire process, from understanding the stepped-up basis rule to getting the professional appraisal you might need.
Your cost basis is essentially your starting point for calculating taxes when you sell property. For most inherited property, you don't use what the original owner paid. Instead, you get what's called a "stepped-up basis" equal to the fair market value on the date of death.
Key Insight: The stepped-up basis can eliminate decades of capital gains tax, potentially saving you tens of thousands of dollars, and it applies to most inherited assets.
Think of it this way: if your grandmother bought her house for $50,000 in 1970, and it's worth $400,000 when she passes away, your cost basis becomes $400,000—not the original $50,000. This eliminates $350,000 of potential capital gains tax, which could save you around $83,000 in federal taxes alone.
The calculation depends on your specific situation. For most inherited property, your cost basis equals the fair market value on the decedent's date of death. This is where you'll likely need a professional appraisal to establish an accurate, defensible valuation. For jointly owned property, the rules vary by state and ownership type. In community property states, both halves of spousal property receive a full step-up. In common law states, typically only the deceased person's portion gets the stepped-up basis.
When we help clients with inherited property appraisals, we often see confusion about which value to use. Remember that it's not what the property cost originally, and it's not what you think it might be worth, your focus should be on the professionally determined fair market value on the specific date of death.
Important: County tax assessments and online estimates won't hold up under IRS scrutiny—you need a certified appraisal.
In some cases, the estate executor can choose an alternate valuation date six months after death instead of using the date-of-death value. This option is only available when filing a federal estate tax return (Form 706) and only if it reduces both the estate's value and the estate tax owed. Here's why this matters to you as a beneficiary: if the executor elects the alternate valuation date, that becomes your cost basis, not the date-of-death value. The executor must apply this election to all estate assets, so they can't pick and choose which properties to value at six months.
For example, if a stock portfolio was worth $2 million at death but dropped to $1.8 million six months later, the executor might elect alternate valuation to reduce estate taxes. Your cost basis would then be based on the lower $1.8 million value. You should receive documentation from the estate about which valuation date applies to your inherited property. If you're unsure, contact the estate attorney or executor for clarification.
Critical Detail: The executor's choice of valuation date directly affects your cost basis and future tax liability.
The step-up happens automatically by law, you don't need to take any special action to "create" it. However, you do need to document and prove your stepped-up basis, especially if the IRS ever questions your tax return. For publicly traded stocks, use the average of the high and low trading prices on that date. For real estate and business interests, you'll typically need a professional appraisal to establish defensible fair market value.
If you're inheriting property from a spouse in a community property state, both halves of the property receive a full step-up to fair market value. This "double step-up" can provide enormous tax savings compared to common law states. Keep detailed records including death certificates, appraisals, estate documents, and any Schedule A forms from the estate. The IRS can audit your return up to three years after filing, so proper documentation is essential.
Tax Advantage: Community property states offer a "double step-up" that can save hundreds of thousands in capital gains taxes.
Figuring out the tax value (basis) of inherited property isn’t always straightforward. For example, if the person who died only had the right to use a property during their lifetime, the person who inherits it may not get a higher “stepped-up” value unless the original owner kept lifetime use, which usually means the property is counted in the estate. Also, if someone gave property to the deceased shortly before they died and then received it back through inheritance, the tax law usually blocks any increase in value for tax purposes.
Business interests can add another layer of complexity. When you inherit an interest in a partnership or LLC, your share is usually adjusted to its current value, and sometimes the business can also increase the value of its assets to reduce future taxes. Finally, if the estate files a federal estate tax return, the value reported there must be used by the heirs. You cannot later claim that the property was worth more for tax purposes.
Tax Tip: If your situation involves any of these complications, consider consulting with a tax professional who understands inherited property rules.
Q. What if the estate didn't get an appraisal at the time of death?
A. You can still get a retroactive appraisal, though it carries less weight with the IRS. The appraiser will use historical data and comparable sales from around the date of death to establish fair market value.
Q. Can I add improvement costs to my inherited property basis?
A. Yes, you can add the cost of capital improvements you make after inheriting the property, such as renovations, additions, or major repairs. Keep all receipts and documentation for these improvements.
Q. What happens if I inherit property with depreciation?
A. If the inherited property was used for rental or business purposes and depreciation was claimed, you may need to "recapture" some depreciation as ordinary income when you sell, even with the stepped-up basis.
Q. How long do I need to keep records of my inherited property basis?
A. Keep all documentation until at least three years after filing the tax return that reports the sale of the property. For added protection against audit, consider keeping records for six years.
Understanding how to determine the cost basis of inherited property puts you in control of your tax situation. The stepped-up basis rule provides a valuable benefit, but only if you document it properly and understand how it applies to your specific circumstances.
At AppraiseItNow, we specialize in inherited property valuations that meet IRS requirements and provide the rock-solid documentation you need to support your stepped-up basis. Our certified appraisers understand the specific requirements for estate and tax purposes, ensuring your valuation will stand up to scrutiny.
Whether you need a date-of-death appraisal for real estate, business interests, or personal property, we deliver fast, accurate, and defensible valuations. Contact AppraiseItNow today to protect your inherited asset tax benefits and ensure you're making the most of this valuable opportunity.
