Basis of Inherited Property for Tax Purposes

The basis of property that you inherit is usually the fair market value of the property at the date of the person’s death. This is the amount you would use to calculate gain or loss for tax purposes if you later sell or dispose of the property, or to calculate depreciation if you use the property in a business or to produce income, such as renting the property. As indicated on the Real Estate Owner website, during times of rising prices, this can be an advantage because the increase in value is passed on without tax. During times of decreasing prices the opposite would be true.

Alternate valuation date

Instead of the fair market value at the date of death, the personal representative for the estate could choose to use an alternate valuation date six months later. As explained by Susan M. Weschler, this is done when the value of the estate assets has declined and the estate tax liability can be reduced by choosing a later valuation date. When the alternate valuation date is chosen, all estate assets are valued as of the alternate valuation date, unless they are sold or distributed after the date of death but before the alternate valuation date. In that case, the assets would be valued as of the date of sale or distribution.

Special use method for a family farm or business

Real property used in farming or a closely held business may be valued according to a special use method if chosen for estate tax purposes. As explained in an article by Martha Eller Gangi and Brian G. Raub, this method is intended to protect family-owned farms and closely held businesses by reducing the federal estate tax burden. Instead of valuing the inherited real property at its fair market value, which may be the potential value for the highest and best use of the property, the property is valued based on its actual use in the family farm or business. In order to use this special use method, the real property must be passed on to a qualified family member and other conditions must be met.

Appreciated property

There is a special rule for the valuation of appreciated property. If you inherit property that you had given to the decedent within one year before the decedent’s death, your basis would be the same as the decedent’s adjusted basis in the property instead of the fair market value at the date of death or alternate valuation death. This rule is intended to prevent taxpayers from transferring property in order to take advantage of a stepped up basis (fair market value rather than cost) and thereby reduce their taxable gain on a subsequent sale of the property.

Community property

As indicated by the IRS, if you live in a community property state you own half the community property. When either spouse dies, the basis of the entire community property becomes the fair market value on the date the spouse dies. So the surviving spouse’s basis would be one-half the fair market value on the date of death, even though that spouse had a different cost basis before. And the basis for the deceased spouse’s heirs would also be half the fair market value.

Sources:
Advantage of Inherited Property – Real Estate Owner
Susan M. Weschler, “Alternate Valuation Date” – suite101.com
Martha Eller Gangi and Brian G. Raub, “Utilization of Special Estate Tax Provisions for Family-
Owned Farms and Closely Held Businesses” – IRS
Publication 551 – Basis of Assets – IRS