When a spouse dies, the rental property you owned together gets a new tax basis equal to its fair market value on the date of death. In a community property state, the entire property resets. In a common law state, only the deceased spouse’s half resets, and your original half keeps its old adjusted basis. That reset, called a step-up in basis, is what determines your depreciation going forward and your capital gain if you sell.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
Basis is the number the IRS uses to measure gain. For a rental, it starts as the purchase price plus improvements and shrinks each year by the depreciation you claim. A property bought for $200,000 and depreciated for twenty years may sit at an adjusted basis of $120,000 even though it’s now worth $500,000. The step-up at death pushes that basis up toward the current value and, with it, erases a large share of the built-in tax.
How Much of the Property Steps Up
The size of the step-up depends on the state you live in. The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.2Internal Revenue Service. Publication 555 (12/2024), Community Property Every other state is common law. The difference between the two can be worth hundreds of thousands of dollars.
Common Law States
Only the deceased spouse’s share resets. If the two of you held the rental jointly, that share is typically 50%. Take a property bought for $200,000 and worth $800,000 at death: your half stays at its original $100,000 basis, your spouse’s half steps up to $400,000, and the combined new basis is $500,000.
Community Property States
The entire property resets, including the surviving spouse’s half. Federal law treats your one-half share of community property as acquired from the decedent for basis purposes, as long as at least half the community interest was includible in the decedent’s gross estate.3Internal Revenue Service. Publication 555 (12/2024), Community Property – Section: Death of Spouse1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent Using the same $200,000 purchase and $800,000 value, the whole property steps up to $800,000. This “double step-up” wipes out the built-in gain.
Splitting the New Basis Between Land and Building
Land doesn’t depreciate, so you have to split the stepped-up value between the two. The IRS method is to multiply the total basis by the fair market value of each component over the fair market value of the whole.4Internal Revenue Service. Publication 551, Basis of Assets A $500,000 appraisal with land valued at $125,000 and building at $375,000 produces a 75/25 split: $375,000 depreciable, $125,000 not. If precise values aren’t available, the IRS permits using local assessed values from the property tax rolls to make the split. The allocation matters because any error here compounds across 27.5 years of deductions.
Restarting Depreciation
With a new, higher basis for the building, you start a fresh depreciation schedule. Residential rental property depreciates over 27.5 years under the general depreciation system.5Internal Revenue Service. Publication 527 (2025), Residential Rental Property – Section: Recovery Periods Under GDS The clock begins on the date of your spouse’s death, and the depreciable amount is the building’s share of the stepped-up value.
In most cases the new annual deduction is substantially larger than what the two of you had been claiming, because a property that was nearly fully depreciated now has a fresh depreciable amount sitting on top of its current market value. Those deductions offset rental income for the next 27.5 years.
What Happens to Prior Depreciation and Suspended Losses
The Recapture Liability Disappears
Had the property been sold during your spouse’s lifetime, prior depreciation would have been “recaptured” and taxed at a rate of up to 25%. The step-up removes that liability. Once the basis is reset to fair market value, the prior depreciation is no longer built in to the basis, so there’s nothing to recapture. On a property carrying $150,000 or more in accumulated depreciation, the savings on this piece alone can exceed $35,000.
Suspended Passive Losses Get Absorbed
Many rental owners carry suspended passive activity losses because their income was too high to deduct rental losses in the year they occurred. These losses don’t transfer to you as a deduction. They’re reduced by the amount of the step-up, and only losses exceeding the step-up are deductible on the decedent’s final return. Anything absorbed by the step-up is gone for good.6Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
Because the step-up on an appreciated rental is usually larger than the suspended losses, those losses typically vanish entirely. A property with $60,000 in suspended losses and a $200,000 step-up loses all $60,000. If the suspended losses were $250,000 against a $200,000 step-up, $50,000 would survive as a deduction on the final return. This is worth working through with a tax professional before that return is filed.
Selling the Property After the Step-Up
If you sell, your capital gain is the sale price minus the new, stepped-up basis. All the appreciation that happened during your spouse’s lifetime drops out of the calculation. A sale shortly after death at a price near the appraised value may produce little or no taxable gain.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
Inherited property also qualifies automatically for long-term capital gains treatment, no matter how briefly you’ve held it after death.7Office of the Law Revision Counsel. 26 USC 1223 – Holding Period of Property A sale weeks after death still gets long-term rates rather than the ordinary-income rates that would apply to short-term gains.
The One-Year Gift Rule
One anti-abuse rule can wipe out the step-up entirely. If you gave appreciated property to your spouse within one year before death, and the property passes back to you (or is sold by the estate with proceeds going to you), there is no step-up. Your basis stays at whatever the decedent’s adjusted basis was immediately before death.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The rule is designed to prevent transferring a low-basis rental to a terminally ill spouse to reset the basis and inherit it back. It doesn’t apply when the property passes to someone other than the original donor or their spouse.
The Alternative Valuation Date
The executor can elect to value the estate as of six months after death instead of the date of death. If the property is sold or distributed within those six months, the value on that date is used instead.8eCFR. 26 CFR 20.2032-1 – Alternate Valuation When the election is made, your new basis follows that alternative date.1Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
The election is only available if it decreases both the gross estate’s value and the total estate tax, and it applies to the entire estate rather than one asset. In practice, that limits it to larger estates owing federal estate tax. For most surviving spouses with a single rental, the date-of-death value controls.
Documenting the New Basis
The whole benefit depends on being able to prove fair market value on the date of death. Without documentation, the IRS can treat the basis as zero, which maximizes the gain on any future sale. Order a qualified appraisal promptly. An appraiser evaluates condition, location, and comparable sales to produce a defensible value as of the specific date of death, and the report becomes the foundation for depreciation, future sale calculations, and any IRS questions. Keep it with a certified copy of the death certificate, the will or deed showing how the property passed to you, and the prior tax records that document the old basis and improvement history.