Most people facing this question are carrying several jobs at once. They are grieving a parent or a spouse, and they now own a building with tenants, a mortgage, and a tax history they did not create. Often they are also serving as executor or successor trustee, with siblings asking whether to keep the place or sell it. This page walks through how the income-tax rules, the depreciation rules and California's property-tax rules apply to an inherited rental. It also names the kind of professional who handles each one.
What Happens to the Tax Basis of an Inherited Rental Property
Basis is the figure the tax law uses to measure gain or loss when property is sold. It is also the starting point for depreciation. For inherited property, federal law resets it. Under 26 U.S.C. § 1014(a), the basis of property acquired from a decedent is generally "the fair market value of the property at the date of the decedent's death." This is commonly called a stepped-up basis, although it can step down if the property lost value.
The statute lists exceptions in the same subsection. The basis may instead be the value on an alternate valuation date if the estate elects it on a federal estate tax return. It may be a special-use value where that election applies. For land, to the extent of the portion of its value excluded from the decedent's taxable estate as a qualified conservation easement, it is the decedent's own adjusted basis. The IRS's Publication 551 also describes a rule for gifts made shortly before death. Under a separate subsection, 26 U.S.C. § 1014(e), if appreciated property was given to the decedent during the one-year period ending on the date of death and it passes back to the person who gave it or that person's spouse, their basis is the decedent's adjusted basis immediately before the death instead of the date-of-death value.
This rule applies to property passing at death. Property given away during life follows different basis rules, so a rental that was deeded to a child years before the death may be treated differently.
The date-of-death value is usually documented by a qualified appraisal as of that date. The IRS's Publication 551 notes that when an estate files a federal estate tax return, beneficiaries generally receive a Schedule A (Form 8971) reporting the value, and certain beneficiaries must use that value. A CPA, an enrolled agent or a tax attorney reviews basis questions for a specific property. The step-up in basis rule matters for every inherited asset, not only rentals.
Depreciation on an Inherited Rental Property
Depreciation is a yearly deduction that recovers the cost of a building over time as it wears out. For an heir who keeps renting, the depreciation the parent was taking does not simply continue. Because the basis is reset at death, the heir generally begins a new schedule using the date-of-death value. Only the building is depreciated, not the land under it. That is why an appraisal that separates the value of the land from the value of the structure is typically needed before the first return is prepared.
Federal law sets the method. Under 26 U.S.C. § 168, the depreciation deduction for tangible property is figured using an applicable method, recovery period and convention. For residential rental property, the method is straight line, meaning equal amounts each full year. The convention is the mid-month convention, which treats the property as placed in service in the middle of the month. The same section defines residential rental property as a building where 80 percent or more of the gross rental income is from dwelling units. The recovery period comes from a table in that section, and a tax preparer applies it.
Depreciation has a second side. When a rental is later sold, the depreciation claimed while the heir owned it is generally taken into account, and part of the gain may be taxed differently from the rest. This is often called depreciation recapture. A CPA or enrolled agent sets up the new schedule and calculates any recapture.
California Property Tax Reassessment and Proposition 19
Property tax is a separate system from federal income tax. Basis governs income tax. Assessed value governs the yearly property tax bill. A family can benefit from the stepped-up basis and still see a higher property tax bill.
The State Board of Equalization explains the default rule on its Change in Ownership – Frequently Asked Questions page. Once the assessor determines that ownership has changed, Proposition 13 requires the property to be reassessed to current fair market value as of the date ownership changed. Only the portion that changes hands is reassessed. That page lists exclusions, including transfers between spouses that happen on the death of a spouse, and certain transfers of a principal residence between cotenants when one dies.
For a parent-to-child transfer, the date of death decides which law applies. The BOE's Proposition 19 page states that Proposition 19 applies to deaths on or after February 16, 2021. For those transfers, Rev. & Tax. Code section 63.2 excludes two kinds of property from reassessment when a claim is filed. The first is the transferor's principal residence, if it becomes the transferee's principal residence within one year and the transferee files for the homeowners' or disabled veterans' exemption within a year. The second is a family farm. Grandchildren qualify only if all of their parents who are the grandparents' children have died. For a qualifying home, any value above the prior taxable value plus $1,000,000 is added. The BOE describes that limit "as biennially adjusted."
A rental home falls outside both categories. The BOE's Proposition 19 page answers that question directly: the transfer of a rental home between parents and children would not qualify for the exclusion. Facts can change the answer. A unit the parent lived in, a building that also contained the parent's home, or a surviving spouse as heir can each be treated differently. The California property tax rules and the Proposition 19 exclusion go further into those facts.
A filing applies whether or not an exclusion does. Under Rev. & Tax. Code section 480, a personal representative files a change in ownership statement for real property subject to probate before or when the inventory and appraisal is filed with the court clerk. In other cases, including a trust, the trustee or the transferee files within 150 days after the date of death. The county assessor's office answers reassessment questions. A property tax consultant or tax attorney handles a contested reassessment.