Overview

Transferring tax basis after a property sale is not a single event but a set of rules that decide which cost basis carries to the new owner and how that basis is adjusted. Basis affects taxable gain when the property is later sold. In my work as a financial planner, I routinely see clients underestimate the tax impact of how basis transfers — especially when gifts, inheritances, depreciation, or 1031 exchanges are involved — which can lead to unexpected tax bills.

This article explains the practical rules, common pitfalls, examples, and recordkeeping steps to protect your tax position. For a deeper primer on calculating basis and capital gains, see our guide on “Calculating Basis and Capital Gain on Property Sales and Exchanges”.

Core rules you need to know

  • Sale to an unrelated buyer: The buyer’s basis is typically the amount they paid (the purchase price). The seller’s basis is used to compute the seller’s taxable gain or loss.
  • Gifted property: Generally uses carryover (donor’s) basis with special adjustments for losses and gift tax paid. See IRS Publication 551 for details (irs.gov/publications/p551).
  • Inherited property: Usually receives a stepped-up (or stepped-down) basis equal to the fair market value on the decedent’s date of death (or alternate valuation date). This often eliminates unrealized gains that accrued during the decedent’s lifetime (IRS topic on inherited property: irs.gov/taxtopics/tc703).
  • Like-kind (Section 1031) exchanges: For qualifying real property exchanges, basis generally carries over to the replacement property with adjustments; gains may be deferred, not permanently avoided (see IRS guidance on exchanges).
  • Depreciated assets (rental property): When basis has been reduced by depreciation, you may owe depreciation recapture taxed differently than capital gains (IRC Section 1250 and related rules).

Why basis matters after a sale

Basis determines your capital gain or loss: Sale price minus adjusted basis equals taxable gain. Mistakes in transferred basis cause overstated or understated gains, wrong tax filings, and potential IRS adjustments. For inherited property, a stepped-up basis can significantly reduce taxable gains; for gifted property, a carryover basis can keep earlier unrealized gains “attached” to the new owner.

Common transfer scenarios and how basis is handled

  1. Sale to an unrelated buyer
  • Buyer’s basis = purchase price plus any qualified closing costs allocated to basis (see “Closing Costs and Tax Basis” for details).
  • Seller reports gain/loss using their adjusted basis (original cost ± improvements ± depreciation).
  1. Gift to a family member
  • Recipient’s basis generally equals the donor’s adjusted basis (carryover basis) for determining gain on a later sale.
  • If the fair market value (FMV) at the time of the gift is less than the donor’s basis and the recipient later sells at a loss, special dual-basis rules apply (IRS Publication 551).
  • If the donor paid gift tax, part of the gift tax may be added to the recipient’s basis (see IRS rules).
  1. Inheritance
  • Most inherited property receives a stepped-up basis to FMV on the decedent’s date of death (or alternative valuation date). The stepped basis often eliminates built-in appreciation before inheritance.
  • Exception: property received from an estate in a community property state may get a full step-up for both spouses in many cases.
  1. 1031 Exchange (like-kind exchange)
  • If you qualify for nonrecognition treatment, basis generally carries over to the replacement property with adjustments for cash received or liabilities assumed. Gains can be deferred but not erased.
  1. Depreciation and recapture
  • For rental or business property, depreciation reduces adjusted basis. When sold, prior depreciation can be “recaptured” and taxed at higher ordinary-income–character rates or a special 25% rate for certain real property.

Practical example (numeric)

You bought a rental property for $300,000. You claimed $60,000 in depreciation over several years and made $40,000 in qualifying improvements. Your adjusted basis before sale is:

Adjusted basis = Purchase price + Improvements – Depreciation
Adjusted basis = $300,000 + $40,000 – $60,000 = $280,000

If you sell for $450,000, taxable gain = $450,000 – $280,000 = $170,000. Part of that $170,000 may be depreciation recapture and taxed separately.

If you instead gifted that property with the donor basis of $280,000, the recipient inherits the same $280,000 basis. If the recipient later sells for $450,000, they’ll face the same $170,000 gain (subject to their tax rates and potential recapture).

If the property were inherited at a $450,000 FMV at death, the beneficiary’s basis would be stepped up to $450,000 and there would be no capital gain on an immediate sale at $450,000.

Reporting and forms

  • Seller: Report gain or loss on Form 8949 and Schedule D (individuals) and on the appropriate business return for corporations or partnerships.
  • Rental/business owners: Report depreciation taken on Form 4562 and include necessary recapture adjustments at sale.

Always check the current IRS instructions for each form because thresholds and reporting details can change (see IRS publications at irs.gov).

Recordkeeping checklist (practical)

  • Original purchase closing statement (settlement statement).
  • Receipts and invoices for capital improvements (not routine repairs).
  • Records of depreciation claimed (tax returns and Form 4562 copies).
  • Documentation of any gift tax paid (Form 709) if a gift was involved.
  • Estate documents and valuation for inherited property.
  • Records of any 1031 exchange paperwork (qualified intermediary statements).

In my practice, clients who keep this documentation avoid the majority of later basis disputes and audit headaches.

Common mistakes and how to avoid them

  • Assuming purchase price equals adjusted basis: forget to add improvements or subtract depreciation.
  • Mixing repairs (expense) with improvements (capitalized) — repairs lower taxable income in the year done; improvements increase basis.
  • Missing depreciation recapture calculations for rental property sales.
  • Failing to check whether a transfer qualifies for step-up or carryover rules (gifts vs inheritances have different tax results).

Professional strategies and planning opportunities

  • Estate planning: A planned transfer at death can create a step-up in basis for heirs, often reducing future capital gains taxes (coordinate with an estate attorney and tax advisor).
  • Gifting: Use gifting strategically when the donor’s basis is low or when the recipient is in a lower tax bracket — but remember gifts carry over basis, so capital gains remain.
  • 1031 exchanges: Use for deferral of gains on investment or business real property, but coordinate timing, qualified intermediary use, and basis adjustments carefully.

When to consult a tax professional

Contact a CPA or tax attorney when:

  • Large appreciated real estate is being gifted or sold.
  • Inheritance or estate planning could trigger step-up calculations.
  • You have claimed significant depreciation on rental property.
  • You are considering a 1031 exchange.

A licensed professional can run scenario modeling and prepare necessary forms; in my experience, early planning reduces surprises and tax costs.

Related resources on FinHelp

Authoritative sources

Disclaimer

This article is educational and not individualized tax advice. Tax rules are complex and change; consult a qualified tax professional or CPA before making decisions based on your situation.