Inherited It, Rented It for Years, Now Selling: Basis and Recapture

Your basis started over at the date-of-death value, and the decedent's history disappeared

Section 1014(a)(1) gives property acquired from a decedent a basis equal to its fair market value at the date of the decedent's death, or the value at the alternate valuation date if the executor elected under section 2032. Publication 551 restates it and adds the community property rule: when one spouse dies in a community property state, both halves of community property generally take the date-of-death value.

Two limits apply. Section 1014(f) says the basis cannot exceed the value finally determined for estate tax purposes, or the value reported on the Form 8971 statement an executor furnishes when an estate tax return was required. Section 1014(e) denies the step-up for appreciated property the decedent received as a gift within one year of death if it passes back to the donor.

The decedent's own depreciation does not follow the property. Section 1250(d)(2) excludes transfers at death from section 1250, and Publication 544 confirms that no gain is reported on depreciable real property transferred to an estate or beneficiary. When you placed the property in service as a rental, you began a fresh 27.5-year straight-line schedule on the building portion of the stepped-up basis, as described in Publication 527.

The depreciation you claimed since is the only recapture you face

Section 1016(a)(2) reduces basis by depreciation allowed, but not less than the amount allowable. If you rented the property and never claimed depreciation, your basis is reduced anyway and the gain is the same; the page on recapture of never-claimed depreciation explains the Form 3115 catch-up.

Residential rental property is depreciated straight line, so there is no additional depreciation and no ordinary income recapture under section 1250(a). Instead section 1(h)(6) defines unrecaptured section 1250 gain as the long-term gain that would be ordinary if section 1250 applied to all depreciation, and section 1(h)(1)(E) taxes it at 25 percent. It is reported through Form 4797 and the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions.

The rest of the gain is long-term capital gain regardless of how long you held the property, because section 1223(9) treats property with a section 1014 basis as held for more than one year. For 2026, Rev. Proc. 2025-32 sets the top of the 15 percent bracket at $613,700 for joint filers and $545,500 for single filers, and the top of the 0 percent bracket at $98,900 and $49,450. Section 1411 adds 3.8 percent on the lesser of net investment income or modified AGI over $250,000 joint, $200,000 single.

A worked example in 2026 figures

Hypothetical, round numbers. You inherited a house in 2016 when it was worth $500,000, with $100,000 allocated to land, and rented it from that year. Depreciation on the $400,000 building at 27.5 years is about $14,500 a year, so after ten years roughly $145,000 has been allowed or allowable. Adjusted basis is $500,000 less $145,000, or $355,000.

You sell in 2026 for $750,000 and pay $45,000 in commissions and closing costs, so the amount realized is $705,000 and the gain is $350,000. Of that, $145,000 is unrecaptured section 1250 gain taxed at up to 25 percent, about $36,250. The other $205,000 is long-term capital gain; for a joint return whose taxable income stays under $613,700 that is 15 percent, about $30,750.

If modified AGI exceeds $250,000, the 3.8 percent tax applies to the lesser of the net investment income or the excess; on the full $350,000 it would be $13,300. Federal tax before state is therefore about $80,000, and the state's own rate comes on top; the state 1031 exchange pages list them. Run your own numbers with your CPA, because the land allocation and the actual depreciation taken change every line.

Three mistakes heirs make: the wrong starting basis, forgotten depreciation and a missing appraisal

The first mistake is using the decedent's purchase price or the assessed value. Basis is fair market value at death, which is usually higher and lowers the gain. If the estate filed Form 706, use the value reported there; if it did not, a date-of-death appraisal or the probate inventory is the evidence. Publication 551 tells you to keep accurate records of every item that affects basis, and the page on selling property owned for decades with no basis records covers reconstruction.

The second is treating unclaimed depreciation as a way to avoid recapture. Section 1016(a)(2) and Publication 551 are explicit that basis is reduced by the full amount of depreciation you could have taken. The remedy is to claim it, which Publication 946 allows through an automatic change in accounting method on Form 3115 with a section 481(a) adjustment that deducts the missed depreciation in the year of change.

The third is forgetting the land. Land is not depreciable, so the stepped-up basis must be split between land and building, and Publication 527 uses the assessed values for real estate tax purposes as the usual ratio. A split that was never made is a split the examiner will make for you.

Where an exchange changes the answer, and when holding for another step-up does

A 1031 exchange into like-kind real estate defers the entire gain, and section 1250(d)(4) limits any recapture to the gain actually recognized, so the 25 percent layer is deferred along with the rest, as explained in whether a 1031 defers depreciation recapture. The replacement property takes the old basis under section 1031(d), so the $145,000 of depreciation in the example stays embedded until a later taxable sale, or until your own heirs receive a fresh step-up.

That last point frames the real decision. If you expect to hold for life, a second step-up at your death erases the deferred gain entirely; the comparison is on 1031 versus holding for the step-up. If you want out of management now, inherited rental 1031 options covers direct replacements and Delaware statutory trusts, and the traditional DST exchange solutions describe the passive route.