Inherited Rental Property Options: Sell, Keep, or 1031 Into Something Bigger?

Your basis reset on the date of death, so a sale in the first year is close to tax-free

Hypothetical: a paid-off house appraised at $400,000 on the date of death and sold eight months later for $420,000 with $25,000 of selling costs. Amount realized is $395,000 against a $400,000 basis under §1014(a), so there is no gain; the parent, with a $100,000 basis, would have owed tax on roughly $295,000.

Two details fix the number. If the executor filed Form 706 (required only when the gross estate exceeds $15,000,000 for 2026 deaths), §1014(f) and Schedule A of Form 8971 cap your basis at the estate-tax value; if no return was required, a qualified appraisal as of the date of death is the document your CPA will want. An executor who elected alternate valuation under §2032 sets basis at the value six months after death instead.

§1223(9) treats inherited property as held for more than one year, so even a sale within months is long-term, and any gain above the stepped-up basis is taxed at 15% or 20% rather than ordinary rates.

Keep it only if 5% on $400,000 beats the alternatives after you price your own hours

The parent's cost is irrelevant now; the question is whether $20,000 of net rent on $400,000 of equity, a 5% yield, is a good use of that equity. Depreciation restarts on the stepped-up basis: if $320,000 of the $400,000 is building, the 27.5-year schedule in Pub. 527 yields about $11,600 a year of deductions, sheltering more than half the rent.

Against that sit the costs an heir often inherits without noticing: a management fee if you live far away, deferred maintenance the parent never did, and a tenant paying below-market rent. Pub. 527's rules for a dwelling unit used as a home also apply if you stay there yourself more than 14 days or 10% of rented days. A tenant paying $1,200 against a $1,700 market rent turns the 5% yield into 3.5% until the lease resets.

• Keep: local, well maintained, market rent, and you are willing to be the landlord.
• Sell: far away, repairs due, and little gain since death.
• Exchange: gain has built up since death, or the estate value was set low, and you want passive income.

A 1031 earns its cost only after the property has climbed past its date-of-death value

With a fresh basis there is nothing to defer, so an heir selling in the first year should simply sell and buy whatever comes next with the cash, without an intermediary. The exchange becomes valuable when time has passed: inherit at $400,000 in 2019, take $40,000 of depreciation, sell in 2026 for $600,000, and the $240,000 gain would cost roughly $10,000 of recapture tax at 25%, $30,000 at 15% and up to $9,120 of net investment income tax under §1411.

That $49,000 is what an exchange defers. The $600,000 can then buy a larger leveraged property, or DST interests spread across two sponsors, while the basis carries over and the deferred gain again disappears at your own death under §1014. Selling costs and the intermediary's fee are the same either way; only the tax column changes.

Heirs who live far away can convert the house into monthly income from a DST, net-lease or managed multifamily interest

A DST is sponsor-managed: Rev. Rul. 2004-86 treats each investor as owning an undivided interest in the trust's real estate, so the interest qualifies as replacement property and arrives without a tenant, a manager or a lender to deal with. A single-tenant net lease shifts taxes, insurance and repairs to the tenant but rests on one lease; a managed multifamily building spreads tenants but keeps you as owner of record.

The comparison that matters is net income after fees and your hours; DST vs direct ownership sets out the trade in detail. Whichever you choose, the $400,000 house rarely needs to be replaced with another house.

Probate, trusts and timing: the taxpayer that sells must be the taxpayer that buys

While the estate is open it is a separate taxpayer filing Form 1041 under Pub. 559, and it can sell or exchange estate property before distribution; after distribution, each heir sells or exchanges in their own name. What you cannot do is sell in the estate's name and buy in yours, so decide before listing whether the exchange happens inside the estate or after the deed passes. Title in the estate's name at the sale closing means the estate's name must also be on the replacement deed.

Property held in a revocable living trust receives the same step-up because it is included in the settlor's gross estate, as Pub. 551 notes; a trust that is irrevocable and outside the estate does not, and those heirs face the parent's old basis. An estate's own capital gains reach the 20% rate at only $16,250 of taxable income in 2026, so ask your CPA whether a sale should occur in the estate or after distribution.

Co-heirs who disagree can split the deed first so each one chooses cash or an exchange

If the estate distributes the property to three children as tenants in common, each child owns an undivided interest that can be sold for cash or exchanged independently; one can go into DSTs while the others take cash. Putting the house into a family LLC before the sale removes that option, because §1031(a)(2) excludes partnership interests from like-kind treatment.

Agree the split, the listing price and the closing timeline in writing before the exchange starts, and confirm each step with your CPA or attorney; the same-taxpayer and co-owner rules are where inherited-property exchanges fail.