Most people facing this question are standing in a parent's or spouse's house, or holding a brokerage statement, while relatives ask whether selling will bring a large tax bill. Some have just been named executor or successor trustee. Others now own part of a home with siblings and are trying to decide what to do with it. The worry is usually the same: the property was bought decades ago for far less than it is worth today. This page explains how the step-up works, how California's community property rules change it, and why property tax is a separate question.
What Step-Up in Basis Means
Basis is the starting value the tax law uses to measure gain or loss when property is sold. If you sell for more than your basis, the difference is gain. If you sell for less, it is a loss.
Under 26 U.S.C. § 1014(a), the basis of property acquired from a person who has died is generally "the fair market value of the property at the date of the decedent's death." Fair market value means what the property would reasonably have sold for on that day. The decedent is the person who died. The rule has exceptions, covered below.
For a family, this matters because the original purchase price usually drops out of the picture. As a hypothetical: a parent bought a house for amount A and it was worth amount B on the date of death. The heir's basis is generally B, not A. If the heir sells for about B, there is little or no gain to report.
The rule covers property received from someone who has died. Property given away while the owner was alive is not described in this rule, and its basis follows different rules. This page does not state tax rates or predict whether any particular sale owes tax.
How the Rule Works Under Federal Law
26 U.S.C. § 1014(a) lists what the new basis is. Generally it is fair market value on the date of death. One alternative is the value on an alternate valuation date, if the executor elects it under 26 U.S.C. § 2032.
That election values estate property six months after death. Property distributed or sold within those six months is valued on the date it is distributed or sold. Under 26 U.S.C. § 2032(c), the election may be made only if it decreases both the value of the gross estate and the estate tax. The IRS FAQ adds that the alternate valuation date applies only if the executor files an estate tax return and makes the election there.
The step-up reaches property acquired "by bequest, devise, or inheritance," among the categories in 26 U.S.C. § 1014(b). It also reaches property the decedent held in a trust they could revoke.
The holding period is also settled. IRS Publication 559 states that if you sell inherited property that is a capital asset, "the gain or loss is considered long term, regardless of how long you held the property."
One exception affects gifts made near death. Under 26 U.S.C. § 1014(e), the step-up does not apply in this situation:
- someone gives appreciated property to a person who dies within one year, and
- the property passes back to the original giver or the giver's spouse.
The giver then takes the decedent's adjusted basis from just before death. IRS Publication 551 states that in this case the basis "is the same as the decedent's adjusted basis in the property immediately before their death, rather than its FMV."
California Community Property and the Double Step-Up
California is a community property state, and property acquired during a marriage is generally community property. That gives a surviving spouse in California an advantage many people have not heard of.
Under 26 U.S.C. § 1014(b)(6), the surviving spouse's one-half share of community property is treated as acquired from the decedent. The condition is that at least half of the whole community interest was included in the decedent's gross estate. IRS Publication 551 explains that when either spouse dies, the total value of the community property, "even the part belonging to the surviving spouse, generally becomes the basis of the entire property." It adds that this applies "whether or not the estate must file a return."
As a hypothetical: a couple bought a home as community property for amount X. At the first spouse's death the home is worth amount Y. Both halves step up, so the surviving spouse's basis in the whole home is Y.
Property held in other ways can come out differently. With joint tenancy or a tenancy in common, the step-up generally reaches only the part included in the decedent's estate. The surviving owner's own share generally keeps its original basis.
The deed, and how title is described on it, is where this starts. Which treatment applies to a specific property is a question tax professionals review against the deed and the facts. California's Franchise Tax Board administers California income tax, including tax on gains from property sales.
Inherited Rental Property and Depreciation
A rental house or small apartment building raises its own set of questions for an heir who is suddenly a landlord. Inherited rental property receives the same step-up to date-of-death value under 26 U.S.C. § 1014(a) as any other inherited capital asset.
The step-up also generally resets depreciation. Depreciation is the yearly deduction for wear on a building. For an heir who keeps renting the property, those deductions going forward are generally figured from the new stepped-up basis, not the decedent's original purchase price. IRS Publication 559 notes that income later produced by inherited property, such as rents, is taxable to the heir.
Depreciation recapture is a separate concept. It is the part of the gain on a rental sale that is taxed differently because of depreciation taken earlier. How recapture applies depends on the particular property and on who claimed the deductions, which is the kind of review a tax preparer handles. The Franchise Tax Board is the source for California's income tax treatment.
Families weighing whether to keep collecting rent often compare these points in a guide to keeping, renting or selling.
Property Tax Reassessment in California: A Separate Question
A step-up in basis is an income tax idea. Property tax is a different body of law, set by California's Constitution under Proposition 13 and by the Revenue and Taxation Code. A family can get a full step-up for income tax and still see the property tax bill rise.
When property transfers at death, the county assessor may reassess it to current market value. Rev. & Tax. Code section 480 requires a change in ownership statement to be filed with the county recorder or assessor in each county where the decedent owned real property.
- Probated property: the personal representative files the statement before or when the inventory and appraisal is filed with the court clerk.
- Property in a trust: the trustee files within 150 days after the date of death.
- Other transfers at death: the person receiving the property files within 150 days after the date of death.
For transfers on or after February 16, 2021, Rev. & Tax. Code section 63.2 can exclude a parent-to-child transfer of the parent's principal residence from reassessment. It can also apply to a grandparent-to-grandchild transfer when the grandchild's parents who are the grandparents' children have died. The conditions include:
- the home becomes the child's principal residence within one year;
- the child files for the homeowners' or disabled veterans' exemption within a year; and
- a claim is filed with the assessor.
The claim is due within three years after the transfer, or before the property goes to a third party or the eligible transferee stops living there, whichever is earlier. A claim is also timely if filed within six months after a notice of supplemental or escape assessment is mailed.
A value test limits how much of the home's worth the exclusion covers. That limit is adjusted over time, and the county assessor or the State Board of Equalization publishes the current figure. The Board prescribes the claim form, and the county assessor's office handles the claim itself. Inheriting a California house brings these filings together in order.
Getting the Basis Right: The Role of a Date-of-Death Appraisal
Proving the stepped-up value usually means having it written down as of the date of death. For real property, that typically takes an appraisal by a licensed appraiser.
Because appraisals often happen weeks or months after the death, the usual method is a retrospective appraisal. That is an appraisal performed later but valued as of the date of death. For publicly traded securities, value is usually taken from market prices on that date, and a separate appraisal is generally not needed.
The person who documents that value is usually the one settling the estate. That is the executor or administrator in a probate, or the successor trustee for trust property. IRS Publication 559 describes a personal representative's primary duties as collecting the decedent's assets, paying the decedent's creditors, and distributing the remaining assets to heirs or other beneficiaries.
When an estate files a federal estate tax return, the executor may give beneficiaries a Schedule A (Form 8971) reporting each property's value. Under 26 U.S.C. § 1014(f), certain beneficiaries' basis cannot exceed that value.
A CPA, enrolled agent or tax attorney reviews the income tax basis question. The county assessor's office handles reassessment. The wider order of these tasks appears in the California estate settlement guide.
When You Sell Inherited Property in California
The IRS FAQ on inherited property answers the most common worry directly: "If you sell the property for more than your basis, you have a taxable gain." In general terms, gain is the sale price minus the stepped-up basis, with adjustments such as selling costs and improvements made after the inheritance. Which adjustments apply depends on the records for the property.
California income tax applies to gains as well. The Franchise Tax Board publishes California's current rates and rules on how gains are taxed, and this page states no rate.
For a surviving spouse or heir who moves into the home, the federal exclusion for the sale of a principal residence may come into play. 26 U.S.C. § 121(a) excludes gain when the seller owned and used the home as a principal residence for periods totaling at least two years during the five years before the sale. The exclusion is subject to a dollar cap the IRS publishes.
For an unmarried surviving spouse, 26 U.S.C. § 121(d)(2) counts the deceased spouse's earlier ownership and use. Whether the exclusion applies depends on the facts of each sale. Who has authority to sell, and how a sale proceeds, are separate steps after this decision.
