Does depreciation restart on inherited rental property?

The step-up resets the basis, and a new basis means a new depreciation schedule

Section 1014(a) gives property acquired from a decedent a basis equal to its fair market value at the date of death, or its value on the alternate valuation date if the executor elects that under section 2032. The decedent's purchase price and every dollar of depreciation they claimed drop out of the calculation. You are treated as having acquired the property on the date of death.

Because the basis is new, the depreciation is new too. IRS Publication 559 says a beneficiary who can depreciate inherited property must use MACRS, and Publication 527 sets the general depreciation system period for residential rental property at 27.5 years. A commercial building is nonresidential real property on a 39-year schedule.

Land is never depreciable, so you need a date-of-death appraisal that separates land from building. Publication 527 allows the property tax assessment ratio when you cannot establish the fair market values directly.

Nobody pays recapture on the depreciation the decedent took

Section 1250(d)(2) and section 1245(b)(2) both say their recapture rules do not apply to a transfer at death, except for income in respect of a decedent. Publication 544 gives the example directly: depreciable property inherited by a child produces no ordinary income from depreciation, even though the estate tax value exceeds the decedent's adjusted basis.

The practical effect is that the decedent's depreciation becomes permanent. When you sell, the 25% rate on unrecaptured section 1250 gain reaches only the depreciation you claim after the date of death, and the gain is measured from your stepped-up basis.

The exception to watch is a sale the decedent agreed to before death. If the decedent had already sold and the proceeds are income in respect of a decedent, the heir reports the ordinary recapture.

Worked example: a $500,000 inherited rental depreciates about $14,545 a year again

Hypothetical, round numbers; run your own numbers with your CPA. Your parent bought a rental house for $200,000 and claimed $120,000 of depreciation, leaving an adjusted basis of $80,000. At the date of death the appraisal values it at $500,000: $100,000 land and $400,000 building.

Your basis is $500,000. The $400,000 building portion is depreciated over 27.5 years, about $14,545 for a full year, with a smaller first year under the mid-month convention. Had your parent sold the day before death, the gain would have been $420,000, including $120,000 of depreciation taxed at up to 25%.

If you sell two years later for $520,000 after claiming roughly $29,000 of depreciation, your adjusted basis is about $471,000 and your gain is about $49,000. Only the roughly $29,000 you claimed is unrecaptured section 1250 gain; your parent's $120,000 is gone.

• Basis to the heir: $500,000, not $80,000.
• Depreciable portion: $400,000 over 27.5 years.
• Recapture exposure on sale: only the heir's own depreciation.

Joint owners, community property and gifts back to the decedent follow different rules

A surviving joint tenant runs two schedules. Publication 559 tells you to continue depreciating your original basis under the same method as before and to depreciate the inherited part using MACRS from the date of death. Under section 1014(b)(9), the basis of the inherited part is also reduced by depreciation you were allowed on it before the death.

In the community property states listed in Publication 551, both halves of community property generally get a new basis when the first spouse dies, provided at least half the value is included in the decedent's gross estate. The planning question of whether to sell or exchange after that reset belongs with the inherited rental options guide.

Section 1014(e) blocks the reset for appreciated property you gave the decedent within one year before death. You take back the decedent's adjusted basis instead, and the old depreciation history comes with it.

What to do in the first year you own it

Get a date-of-death appraisal that values land and building separately, and if an estate tax return was required, use the value on the Schedule A (Form 8971) the executor sends you; Publication 551 says certain beneficiaries must use that value as their initial basis. Report the new building on Form 4562 for the year you place it in service.

Expect no bonus depreciation on inherited components. Used property qualifies for the special allowance in section 168(k) only if it meets the purchase rules in section 179(d)(2), and those exclude property whose basis is determined under section 1014(a). A cost segregation study can still sort the new basis into shorter regular MACRS classes, such as 5-year appliances and 15-year land improvements.

If you exchange the inherited rental later, the replacement inherits your post-death basis, not the decedent's. Under Reg. section 1.168(i)-6 the carried-over basis generally continues on the relinquished property's remaining schedule, and any excess basis starts fresh; how depreciation works on a replacement walks through that split.

When a DST changes the answer

An heir who does not want to manage the property can sell and exchange into a Delaware statutory trust interest, which Rev. Rul. 2004-86 treats as an interest in real property for section 1031. Because your basis was just reset, the gain to defer may be small, so compare the exchange cost against the tax on the traditional DST page.

The trust's depreciation flows through to you on your share of its building, which keeps sheltering part of the income the way your own depreciation did. Whether that is worth the trust's illiquidity is the question in inherited, then rented: basis and recapture.