Key Takeaways
- Inherited property receives a stepped-up basis to FMV at the date of death (or alternate valuation date 6 months later)
- Inherited property is automatically treated as long-term capital property, regardless of how long the decedent or heir held it
- In the 9 community property states (AZ, CA, ID, LA, NV, NM, TX, WA, WI), both halves of community property receive a stepped-up basis when one spouse dies
- Gifted property uses carryover basis (donor's basis) for gains, but the lower of donor's basis or FMV at gift date for losses (the dual-basis rule)
- For 2024, the annual gift tax exclusion is $18,000 per donee, and the lifetime gift/estate tax exemption is $13.61 million
Inherited Property Basis (Stepped-Up Basis)
When you inherit property from a decedent, the property receives a stepped-up basis (or stepped-down basis if the property has declined in value). This rule, found in IRC Section 1014, is one of the most valuable tax benefits in the Internal Revenue Code.
General Rule: FMV at Date of Death
The basis of inherited property equals the fair market value (FMV) on the date of the decedent's death. This "step-up" eliminates all unrealized appreciation that occurred during the decedent's lifetime.
Example: Your grandmother purchased stock for $10,000 in 1980. When she passes away in 2024, the stock is worth $200,000. Your basis in the inherited stock is $200,000 - the $190,000 of appreciation is never taxed.
Alternate Valuation Date (IRC Section 2032)
The executor of the estate may elect to use the alternate valuation date, which is 6 months after the date of death. This election:
- Must reduce both the gross estate value AND the estate tax liability
- Applies to ALL estate assets (no cherry-picking)
- Is irrevocable once made
- Only applies to estates required to file an estate tax return (estates over $13.61 million in 2024)
Important: If property is distributed, sold, or disposed of within 6 months of death, it is valued on the date of distribution/sale, not at the 6-month mark.
Holding Period for Inherited Property
Under IRC Section 1223(9), inherited property is automatically treated as long-term capital property, regardless of:
- How long the decedent held the property
- How long the heir holds the property before selling
This means you could inherit stock on Monday and sell it on Tuesday - any gain would still qualify for the lower long-term capital gains rates (0%, 15%, or 20% depending on income).
Community Property Stepped-Up Basis
One of the most significant tax advantages exists in community property states. When one spouse dies:
The "Double Step-Up" Rule (IRC Section 1014(b)(6))
In community property states, BOTH halves of community property receive a stepped-up basis - not just the decedent's half. This means the surviving spouse's half also gets stepped up to FMV at death.
The 9 Community Property States
| State | State |
|---|---|
| Arizona | Nevada |
| California | New Mexico |
| Idaho | Texas |
| Louisiana | Washington |
| Wisconsin |
Note: Alaska, Florida, Kentucky, South Dakota, and Tennessee allow community property trusts for couples who want to opt in.
Example: Community Property vs. Separate Property
Facts: A married couple purchased a home for $200,000. At the first spouse's death, the home is worth $600,000.
| Scenario | Surviving Spouse's Basis | Potential Tax Savings |
|---|---|---|
| Community Property State (e.g., California) | $600,000 (full step-up) | $0 capital gain if sold for $600,000 |
| Separate Property State (e.g., Florida) | $400,000 ($300,000 stepped-up half + $100,000 original half) | $200,000 subject to capital gains tax |
At 15% capital gains rate, the community property treatment saves $30,000 in federal taxes!
Gifted Property Basis (Carryover Basis)
When you receive property as a gift during the donor's lifetime, the basis rules are more complex. The general rule is carryover basis - you take the donor's adjusted basis. However, the dual-basis rule applies when property has declined in value.
Gain Basis: Donor's Adjusted Basis
For purposes of calculating a gain on sale, your basis equals the donor's adjusted basis at the time of the gift. The donor's holding period also "tacks on" to yours.
Loss Basis: The Dual-Basis Rule
When the FMV at the time of gift is LESS than the donor's adjusted basis, a special rule applies:
- For calculating GAIN: Use the donor's adjusted basis
- For calculating LOSS: Use the FMV at the date of gift
This creates a possible "no gain/no loss zone" when you sell the property between the two basis amounts.
Dual-Basis Example
| Donor's Basis | FMV at Gift | Sale Price | Result |
|---|---|---|---|
| $20,000 | $15,000 | $25,000 | Gain of $5,000 (using $20,000 donor's basis) |
| $20,000 | $15,000 | $12,000 | Loss of $3,000 (using $15,000 FMV basis) |
| $20,000 | $15,000 | $17,000 | NO GAIN OR LOSS (in the "dead zone") |
Holding Period for Gifted Property
- For gains: The donor's holding period tacks onto yours
- For losses: Your holding period starts on the date of the gift (when FMV basis applies)
Gifted Property with Gift Tax Paid
If the donor paid gift tax, a portion of that tax can be added to the donee's basis. This adjustment only applies for calculating gains, not losses.
The Formula (IRC Section 1015(d)(6))
Basis Increase = Gift Tax Paid x (Net Appreciation / Taxable Gift Amount)
Where:
- Net Appreciation = FMV at gift - Donor's adjusted basis
- Taxable Gift Amount = FMV at gift - Annual exclusion ($18,000 in 2024)
Example Calculation
Facts:
- Donor gives property with FMV of $100,000 and adjusted basis of $40,000
- Gift tax paid: $10,000
- Net appreciation: $100,000 - $40,000 = $60,000
- Taxable gift: $100,000 - $18,000 = $82,000
Basis Increase: $10,000 x ($60,000 / $82,000) = $7,317
Donee's Basis for Gain: $40,000 + $7,317 = $47,317
Note: The adjusted basis can never exceed the FMV at the time of gift.
2024 Gift Tax Thresholds
| Threshold | 2024 Amount |
|---|---|
| Annual Gift Tax Exclusion (per donee) | $18,000 |
| Married Couple (gift splitting) | $36,000 per donee |
| Lifetime Gift/Estate Tax Exemption | $13.61 million |
| Gift Tax Rate (above exemption) | Up to 40% |
Part Gift/Part Sale (Bargain Sale)
When property is transferred for less than FMV with donative intent, the transaction is treated as part sale and part gift.
Rules for Bargain Sales to Individuals
- Gain recognized: Only if amount realized exceeds the donor's ENTIRE adjusted basis
- No loss recognized: Even if amount realized is less than basis
- Donee's basis: The greater of (1) the amount paid or (2) the donor's adjusted basis
Example: Part Gift/Part Sale
Facts: Father sells property to son for $60,000. Father's basis is $30,000, and FMV is $90,000.
- Father's gain: $60,000 - $30,000 = $30,000 recognized gain
- Gift portion: $90,000 - $60,000 = $30,000 (gift element)
- Son's basis: $60,000 (amount paid, which exceeds father's basis)
Inherited vs. Gifted Property: Comparison Table
| Factor | Inherited Property | Gifted Property |
|---|---|---|
| Basis | FMV at death (stepped-up) | Donor's basis (carryover) |
| Holding Period | Automatically LONG-TERM | Tacks onto donor's period (for gain) |
| Losses | Full FMV basis for losses | Lower of donor's basis or FMV |
| Gift Tax Adjustment | N/A | May increase basis (gain only) |
| Community Property | Double step-up available | N/A |
| Planning Advantage | Better for appreciated property | Better for depreciated property (loss) |
Tax Planning Tip: Highly appreciated assets should be held until death to receive the stepped-up basis, while depreciated assets may be better sold before death to recognize the loss.
Mary inherits 100 shares of ABC stock from her deceased father. Her father purchased the stock for $5,000, and it was worth $25,000 on the date of his death. Six months later, when Mary sells the stock for $27,000, what is her taxable gain and how is it characterized?
John and Susan, married residents of California (a community property state), purchased their home for $400,000. When John dies, the home is worth $1,000,000. What is Susan's basis in the home after John's death?
Tom gives his daughter Emily stock with a basis of $30,000. At the time of the gift, the stock is worth $20,000. Emily later sells the stock for $25,000. What is Emily's gain or loss on the sale?
For 2024, what is the annual gift tax exclusion amount per donee, and what is the lifetime gift and estate tax exemption?