For capital gains purposes, what is the step up basis on inherited real estate?

When a person (the beneficiary) receives an asset from a giver (the benefactor) after the benefactor dies, the asset often receives a stepped-up basis, which is its market value at the time the benefactor dies (Internal Revenue Code § 1014(a)). A stepped-up basis is often much higher than the before-death cost basis, which is primarily the benefactor's purchase price for the asset. Because taxable capital-gain income is the selling price minus the basis, a high stepped-up basis can greatly reduce the beneficiary's taxable capital-gain income when the beneficiary sells the inherited asset.

Brian: Hi, Tom. Thanks for taking my call. I have a question in regards to inheriting real estate. If I inherit real estate from a family member and then I sell it, what are the tax implications?

Attorney Tom Olsen: Brian, when you inherited this piece of property, you got what's called a stepped-up basis for capital gains tax purposes. When you inherited this piece of property, your basis for capital gains tax purposes was a value at the date of death. Let's just say it was your uncle, for example. If your uncle died last month and you turn around and sell it next month, then you're going to pay no capital gains because you got a stepped-up basis.

If you hold onto that property for a few years, and then you sell it, you're going to pay capital gains on what the appreciation of that property from the time that your uncle passed away through the time that you sold it. Brian, does that answer your question for you?

Brian: Yes. If I had the option of reinvesting it into another piece of property, I could do so with a 1031?

Attorney Tom Olsen: Brian, you'd only be-

Brian: If it was an investment piece of property?

Attorney Tom Olsen: It would, but Brian, how long ago did you inherit this piece of property?

Brian: It's coming up in the future and we're trying to decide whether to keep it or reinvest.

Attorney Tom Olsen: Brian, what I'm saying is, is that when you inherit this property and you turn right around and sell it, because of the stepped-up basis, you're not going to pay any capital gains taxes. When you talk about doing a 1031 exchange, you're using that when you do have to pay capital gains taxes, this is a situation where there will not be capital gains taxes due.

Brian: Got you. Okay, I appreciate it. Thank you very much.

Attorney Tom Olsen: All right. The step-up basis, Chrissy, is a great thing. It's a good provision within the Internal Revenue Code. It's available for any kinds of assets, including real estate, or if you bought Tesla stock way back in the-- not even that long ago, back in the day, you get a stepped-up basis, or the painting hanging on your living room wall.

Attorney Chris Merrill: Exactly. You're right, Tom. When you also mentioned as far as step-up basis, and that is of course the capital gains on any one of those items with regards to the IRS that is different than inheritance, death taxes.

Attorney Tom Olsen: Exactly. We're talking about something different there. Let's put out this little thing to think about [unintelligible 00:02:36] because occasionally I read about the US Congress talking about getting rid of the step-up basis. It's not beyond the possibility. I've heard of them talking about it during Republican administrations and probably they're going to be talked about during president-elect Biden's administration. Be aware of that folks. This is a gift. It's a good thing. It's a good provision. It may be taken away. Just pay attention to it.