What is “Step-Up in Basis” in Real Estate (2025)

August 16, 2025 by Nicole Fishman Benoliel

The step-up in basis for real estate is an important tax provision that applies to properties and other assets transferred upon death. This provision allows heirs to inherit property at a new basis equal to the fair market value of the property at the time of the decedent’s death. As a result, when the heirs sell the property, they only owe capital gains taxes on any appreciation that occurs after the date of inheritance, rather than on the original cost basis of the decedent, who may have acquired it for much less.

This provision can offer significant tax advantages for real estate investors under the tax law.

If they hold the property until their death, their heirs can inherit the property at its fair market value rather than the depreciated cost basis the decedent had. This not only helps the original owners benefit from reduced income tax liabilities due to depreciation.

At the same time, they own the property. But it also allows the heirs to largely avoid capital gains tax when they eventually sell the property.

Woman sitting at a table with a calculator and documents

Is stepped-up basis a loophole?

The question of whether the step-up in basis at death represents a loophole in the U.S. tax code is a subject of debate. Perspectives on this issue often vary depending on individuals’ political views and their stance on tax policy and wealth transfer. Below, we will examine arguments from both sides.

Reasons Why the Step-Up in Basis is Considered a Loophole

Tax Avoidance for the Wealthy. The step-up in basis allows wealthy individuals to pass on assets to their heirs without incurring capital gains tax. When heirs inherit these assets, they receive a stepped-up basis at the time of the original owner’s death, enabling them to sell the assets without paying capital gains tax on the appreciation that occurred during the original owner’s lifetime. This can lead to significant tax savings for the heirs.
Contribution to Wealth Inequality: Critics argue that the step-up in basis exacerbates wealth inequality. By permitting wealthy individuals to transfer substantial amounts of wealth to their heirs without taxes on the appreciation accumulated during their lifetimes, it perpetuates wealth disparities and makes it more difficult for others to build their wealth.
Inconsistent Treatment of Asset Types: The step-up in basis only applies to specific asset classes, including stocks, bonds, and real estate. Other types of assets, including art, jewelry, and collectibles, do not receive a stepped-up basis upon the original owner’s death. This leads to inconsistencies the treament of different types under the tax code.
Depreciation of Rental Property: Notably, rental properties can be fully depreciated over time (specifically, 27.5 years for residential property), which can result in a zero cost basis by the time the owner passes away.

Real estate investors can enjoy significant tax benefits by fully depreciating their rental properties over their lifetime.

By doing so, they can reduce their income tax liability while holding the property until their death. When they pass the property on to their heirs, they won’t have to pay capital gains tax because they never sold the property, nor will they incur depreciation recapture taxes, which typically amount to 25%.

This means that real estate investors can fully utilize depreciation to reduce their income taxes throughout their lifetime. If they retain ownership of the property until their death, they can also avoid capital gains tax on any appreciation the property has experienced, as well as avoid paying depreciation recapture.

Note that you cannot depreciate land itself. You can only depreciate the structure of the property. However, in practice, accountants may fully depreciate the value of a condo or co-op apartment, considering the land ownership portion to be insignificant, especially in larger buildings with many units.

Inherited property tax basis

When a person inherits property from a deceased individual, the property’s value for tax purposes is typically “stepped-up” to its fair market value at the time of the original owner’s death. This means that the heir’s tax basis in the inherited property is equal to the property’s fair market value at that time, rather than the original purchase price.

For example, if someone inherits a house from their deceased parent and the fair market value of the house at the time of the parent’s death is $500,000, the heir’s tax basis in the inherited property would be $500,000.

This is in contrast to the parents’ original purchase price of $200,000. The tax basis is “stepped-up” to the fair market value at the time of the parent’s death.

This stepped-up basis can provide a significant benefit to heirs, as it may reduce the amount of capital gains tax they owe if they decide to sell the inherited property.

If the heir sells the property for a price that is equal to or less than the stepped-up basis, they will not owe any capital gains tax on the sale.
However, if they sell the property for more than the stepped-up basis, they will be responsible for paying capital gains tax on the difference between the sale price and the stepped-up basis.

How is fair market value determined?

To determine the fair market value of an asset at the time of the original owner’s death, it is often necessary to hire a qualified appraiser to provide an appraisal report.

This report should include a detailed description of the appraised property, along with an explanation of the valuation methods used and any assumptions made during the process.

The valuation date is typically the date of the original owner’s death. However, there are exceptions.

For instance, if the estate qualifies for the alternate valuation date, you can set this date to six months after the date of the original owner’s death. The estate may elect to use the alternate valuation date if the total value of the estate at that time is lower than the total value on the date of the original owner’s death.

Step-up basis capital gains or losses

The step-up in basis is a significant benefit for heirs, as it can help reduce the capital gains tax they may owe when selling inherited property. If the heir sells the property for an amount equal to or less than the stepped-up basis, they will not owe any capital gains tax. However, if they sell it for more than the stepped-up basis, they will be liable for capital gains tax on the difference between the sale price and the stepped-up basis.

For example, suppose an individual inherits a stock portfolio from their deceased parent. The value of the portfolio at the time of the parent’s death is $500,000, while the parent originally purchased it for $200,000. If the heir sells the stock portfolio for $600,000, their capital gains tax liability will be based on the $100,000 difference between the sale price and the stepped-up basis.

Conversely, if the heir sells the stock portfolio for $450,000, they will not owe any capital gains tax, since the sale price is less than the stepped-up basis.

It’s also important to note that any sale of inherited property qualifies for long-term capital gains tax treatment, regardless of when the heir sells the property—whether a year or just a month after the time of death.

Step-up in basis estate tax

Contrary to popular belief, the step-up in basis for real estate is not just a loophole that wealthy families exploit to avoid estate taxes when transferring wealth across generations. Instead, it provides a significant benefit to the decedent during their lifetime by reducing their income tax liability.

Consider this: A real estate investor who fully depreciates a rental property can enjoy the advantage of showing paper losses against their income tax liability over many years—specifically, for 27.5 years for residential properties. Unless they choose to utilize a 1031 exchange, when the investor eventually sells the property, they typically will have to pay not only capital gains tax but also a depreciation recapture tax at a rate of 25%.

This means that the tax savings from depreciation are essentially a temporary benefit that the surviving spouse pays back at the time of the sale (assuming it is for more than the remaining cost basis). However, if the investor never sells the property, they effectively benefit from a reduced income tax liability for many years to come.

In this context, it doesn’t seem fair for the next generation to be responsible for any capital gains taxes resulting from the investor’s death.

Step-up in basis is not an estate tax loophole.

When an heir inherits a rental property, they pay taxes on its full fair market value. This value is deducted from the deceased’s lifetime estate and gift tax exemption, meaning that the estate tax cannot be entirely avoided through the step-up in basis.

This approach is relatively fair. In certain markets, such as New York City before 2020, real estate is a form of tax arbitrage. In these instances, depreciation represented a paper loss, regardless of the property’s actual age.

For example, an older townhouse or condominium in the West Village continues to appreciate over time. Conversely, markets like South Florida often experience genuine depreciation. This depends on factors such as a lack of supply constraints, weather-related wear and tear, and a general preference for newer properties.