Inheriting a house or investment property in Washington usually comes with a tax advantage most heirs do not fully appreciate until they sell: stepped-up basis. Capital gains tax on inherited property is calculated using the property's fair market value on the date of the original owner's death, not what that owner originally paid decades earlier, which can eliminate most or all of the gain an heir would otherwise owe if they sell relatively soon after inheriting.
How Stepped-Up Basis Actually Works
Under current law, when a property passes to an heir through inheritance, its basis resets to fair market value as of the date of death, generally established through a formal appraisal or, in some cases, county assessor records adjusted to reflect that date. A rental duplex in Renton purchased decades ago for 80,000 dollars and worth 650,000 dollars at the owner's death passes to the heir with a basis of 650,000 dollars, not 80,000 dollars, meaning decades of appreciation that would have been taxable to the original owner simply disappears from the tax calculation for the heir.
What Happens If The Heir Holds The Property For A While
Because the basis resets at death, an heir who sells shortly afterward typically owes little or no capital gains tax, since the sale price and the stepped-up basis are often close in value. If the heir instead holds the property for several years, ordinary appreciation from that point forward becomes taxable in the normal way, calculated as any other capital gain from the new, higher basis rather than the original purchase price. An heir who rents the property out during that holding period also begins accumulating fresh depreciation on the stepped-up value, which will itself become subject to recapture on a future sale.
Multiple Heirs And Divided Interests
Inherited property is frequently owned by several siblings or family members jointly, and each heir's basis is generally established independently based on their proportional interest at the date of death. Complications arise when heirs disagree about whether to sell, rent, or occupy the property, or when only some heirs want to cash out. In those situations a partition sale, a buyout among the heirs, or in some cases a 1031 exchange by one or more of the co-owners while others sell their share outright, can resolve the disagreement without forcing every heir into the same decision.
Using A 1031 Exchange After Inheriting Investment Property
An heir who inherits a property that was, or becomes, held for investment or business use, a rental house in Kirkland, for example, can use a 1031 exchange on a future sale just as the original owner could, deferring any gain that accrues after the stepped-up basis date. This is particularly useful for heirs who want to diversify out of a single concentrated asset, such as one large rental property inherited jointly with siblings, into multiple smaller replacement properties, or into a passive structure like a DST, without triggering tax on the appreciation that has built up since the date of death.
Heirs who plan to sell relatively quickly after inheriting often find that stepped-up basis alone minimizes the tax enough that a 1031 exchange is unnecessary, since there may be little or no gain to defer. The calculation changes for heirs who hold the property for years while it appreciates further, or who inherited jointly with siblings and want to consolidate proceeds into a different investment without splitting the transaction into several smaller taxable sales. In either case, working out the exact stepped-up basis figure with a qualified appraisal early, rather than estimating it from memory or an old tax bill, is the foundation every other decision depends on.
Common Questions
What is stepped-up basis for inherited property?
It is the resetting of a property's cost basis to its fair market value on the date of the original owner's death, which generally reduces or eliminates the taxable gain an heir would owe if they sell soon after inheriting.
Do I owe capital gains tax if I sell inherited property right away?
Often very little, since the sale price and the stepped-up basis tend to be close in value shortly after death, though a formal appraisal is generally needed to document the exact basis figure.
What happens to stepped-up basis if I hold the inherited property for years?
Appreciation that occurs after the date of death becomes taxable in the normal way when the property is eventually sold, calculated from the stepped-up basis rather than the original owner's purchase price.
Can multiple heirs each use a 1031 exchange on their share of an inherited property?
In many structures, each co-owner can independently decide whether to sell their share outright or use a 1031 exchange on their portion, though the specific ownership structure needs review to confirm this is available.
Is a 1031 exchange still useful if stepped-up basis already eliminates most of the gain?
It depends on the situation; heirs selling soon after inheriting may have little gain to defer, but those who hold the property longer, or want to consolidate several inherited interests, often still benefit from an exchange.