Inherited Rental Property

The Stepped-Up Basis and What It Means for a Rental Property

Basis is the starting figure used to measure taxable gain when property is sold. Under 26 U.S.C. § 1014(a), the basis of property acquired from a decedent is generally "the fair market value of the property at the date of the decedent's death." The statute gives alternatives: a value at an alternate valuation date when that election is made, a special-use value when that election is made, and the decedent's own basis to the extent a conservation-easement exclusion applies. The IRS's Publication 551, Basis of Assets adds that the alternate valuation date applies if the personal representative chooses it.

This matters more for a rental than for most inherited homes. A parent who owned a building for decades may have bought it cheaply and claimed depreciation deductions for years, which lowered their own basis. The heir's basis is the value the statute gives, not the parent's purchase price less depreciation. The gap between that value and a later sale price, rather than the parent's original figure, is generally what is measured. A rise or fall in value after death does not change the basis itself. The full idea of step-up in basis runs deeper than this summary.

For a surviving spouse, IRS Publication 551 says that in community property states, including California, the total value of community property generally becomes the basis of the entire property when either spouse dies, provided at least half of the community interest is includible in the decedent's gross estate.

A CPA, an enrolled agent or a tax attorney reviews the basis figure and whether any tax is owed on a sale. This page offers information, not tax advice.

Proposition 19 and Property Tax Reassessment

The parent-child exclusion is narrower than many families remember. Reassessment means the county assessor sets a new taxable value for the property instead of carrying forward the parent's older, often much lower one, and the annual tax bill can rise as a result.

For transfers on or after February 16, 2021, Rev. & Tax. Code section 63.2 governs the exclusion. It covers a principal residence of the parent that becomes the child's principal residence within one year of the transfer, or a family farm, and it reaches grandchildren only if all of the grandchild's parents who are children of the grandparents are deceased. The child also has to file for the homeowners' or disabled veterans' exemption within a year. The State Board of Equalization's Proposition 19 page says plainly that the transfer of a rental home between parents and children would not qualify.

Families who recall a parent passing along a low tax bill on a rental may be remembering the older Proposition 58 rules. The Board says Proposition 58 applies to dates of death on or before February 15, 2021, and Proposition 19 to dates of death on or after February 16, 2021, because the date of death is the date of change in ownership.

Where an heir moves into the property, the exclusion also has a value limit. The Board's Proposition 19 Fact Sheet (Publication 801) sets it at the taxable value plus an adjusted amount, which is $1,044,586 for transfers from February 16, 2025, through February 15, 2027. The Board publishes each new adjusted figure.

Under Rev. & Tax. Code section 63.2, a claim is filed within three years of the transfer, or before the property is transferred to a third party, or before an eligible transferee stops living there, whichever is earlier. It is also timely within six months after a notice of supplemental or escape assessment is mailed. A later claim, if the property has not gone to a third party, applies starting with the lien date of the year it is filed. The county assessor's office handles reassessment questions and exclusion claims. How property taxes on an inherited rental work in a given county is its call.

Existing Tenants: Rights, Leases, and Rent Control

A tenancy generally does not end because the owner died. The heir, the trustee or the estate steps into the prior owner's place, and both fixed-term leases and month-to-month tenancies carry on. For a transfer on death deed, Probate Code section 5652 says the property passes subject to limitations of record, expressly including a lease, and the holder of those rights may enforce them.

Several duties follow the property:

• Owner contact details. Under Civil Code section 1962, a successor owner or manager must give the tenant the owner, manager and rent-payment information within 15 days of succeeding. A successor may not evict for nonpayment of rent that accrued while it was out of compliance, although the tenant still owes that rent.
• Security deposits. Under Civil Code section 1950.5, the landlord holds the deposit for the tenant, and the tenant's claim to it comes before any creditor of the landlord.
• Just cause. Under Civil Code section 1946.2, part of the Tenant Protection Act, once a tenant has continuously and lawfully occupied the property for 12 months, the owner generally may not end the tenancy without just cause stated in a written notice. Separate conditions apply when adult tenants were added before an existing tenant reached 24 months.

Local rent control ordinances in cities such as Los Angeles, San Francisco and Oakland generally apply to the property rather than to a particular owner, so an heir takes title with those rules in place. Whether the statewide act or a local ordinance covers a specific building is a question for an attorney familiar with California landlord-tenant law.

Selling with tenants in place is possible, but it narrows the pool of buyers. A buyer who wants to live there relies on owner move-in as a no-fault just cause under Civil Code section 1946.2. That cause comes with conditions, including written agreement or a lease provision for leases entered into on or after July 1, 2020, and a move-in within 90 days for at least 12 consecutive months. More on selling with tenants in place follows from those rules.

Depreciation, Rental Income, and Tax Obligations While the Estate Holds the Property

Rent keeps arriving while a probate case or a trust administration runs. Rental income an estate or trust receives during that time is generally its own taxable income, and the estate or trust generally files its own income-tax return, separate from the heirs' returns.

Once the property is distributed, an heir who keeps renting it generally figures depreciation going forward from the date-of-death basis described above, rather than from the parent's old schedule, and reports the rental income on their own return.

Families juggling a tenant's repair request and an estate's first tax season at once are in a common spot. A CPA, an enrolled agent or a tax attorney handles the returns for the estate, the trust and the heir, and settles how depreciation is figured.

Dividing an Inherited Rental Property Among Multiple Heirs

Heirs who inherit together become co-owners, each holding a fractional share. A co-owner is one of several people who hold title at the same time. Under Probate Code section 5652, two or more beneficiaries of a transfer on death deed generally take the property as tenants in common, in equal shares. A will or trust can set different shares.

The practical paths are:

• A buyout. One heir buys the others' shares.
• A sale. The heirs sell and divide the proceeds by their shares.
• Continued ownership. The heirs keep renting together, ideally under a written co-ownership agreement covering expenses, decisions and an eventual exit.

California's partition statutes generally allow a co-owner to ask a court to divide the property, and a court may order it sold where physical division is not practical. Where heirs are in conflict or misconduct is suspected, that contested matter is handled by an attorney who litigates trust and probate cases.

Co-owners who agree on selling usually compare written offers and estimated net proceeds: the price less commissions, repairs, carrying costs, loan payoffs and closing costs. The costs of selling inherited property are the inputs to that figure.

Selling an Inherited Rental Property: The Main Approaches

The seller's authority comes first. In probate, Probate Code section 10308 says that, except as provided in Probate Code section 10503, all sales of real property must be reported to and confirmed by the court before title passes. If the personal representative does not file the report and petition within 30 days after the sale, the purchaser may file them. Under Probate Code section 10503, the court-confirmation requirements, such as published notice of sale, court approval of agents' and brokers' commissions, sale at not less than 90 percent of appraised value and the court's examination of the sale, do not apply to a sale made with that authority. Whether that authority exists depends on what the court granted and whether anyone objects to a notice of proposed action. How an executor selling inherited property gets there turns on those facts.

With authority settled, there are three main approaches:

• Listing with a licensed agent. The property goes to the open market. That often brings the most competition, but it costs a commission and takes preparation, showings and, with tenants, coordinated access.
• Selling without an agent. The seller handles pricing, marketing, showings and paperwork, keeping the commission but carrying the work.
• A direct sale. A buyer pays cash and takes the property in its present condition. That buyer absorbs repairs, risk and the expense of reselling, so a direct offer is often lower than what the open market might bring. The seller gets less preparation, fewer showings and less dependence on a buyer's loan.

Tenants affect each approach. Some buyers purchase with tenants in place, and others want the property vacant.

The estate's authority, the court's steps and the law's duties are the same whoever the buyer is. A cash sale does not avoid probate, a confirmation, a notice, a disclosure, a lien or a tax.

On disclosures, Civil Code section 1102.2 says the disclosure article it belongs to does not apply to some sales, including sales ordered by a probate court and sales by a fiduciary administering a trust or a decedent's estate. The fiduciary exemption does not apply where the trustee is a natural person who is a trustee of a revocable trust and is a former owner of the property or was an occupant in possession within the preceding year. Other disclosure duties may still apply, and the estate's or trust's attorney or a licensed agent can say which ones.

A reader can get an offer on an inherited property from Silver Lining Inherited Property, for a direct as-is sale; a direct offer is often lower than an open-market price, and asking for one carries no obligation to sell.

Is It Better to Sell or Keep Renting an Inherited Property?

No single answer fits every heir. The answer depends on the heir's taxes, the building's condition, the co-owners and the distance from the property.

Keeping and renting brings ongoing rental income and a new depreciation starting point from the date-of-death basis. It also usually means property tax at a reassessed value, since a rental generally falls outside the Proposition 19 exclusion, along with landlord duties under the tenant rules above. An heir several hours away carries the added work of finding a manager or handling calls from far off.

Selling soon after death means the gain, if any, is generally measured from a basis close to the current value. Proceeds can be divided among co-heirs by their shares, and the ongoing management and carrying costs end.

A CPA or tax attorney compares the after-tax results of each path for a particular family. A fuller comparison of whether to sell or rent an inherited property weighs those results against the family's time and goals.