Depreciation Recapture Rules When Selling Inherited Real Estate

So, you’ve inherited a rental property. Congrats… and condolences, of course. Now let’s talk taxes—the least emotional part of inheritance, but possibly the most expensive.

Most heirs think they can sell an inherited property and pocket the money without dealing with any of the previous owner’s tax baggage. And while that’s often true, things can get murky when depreciation enters the chat.

Let’s unpack what depreciation recapture means, when it applies, and how you can avoid unpleasant surprises come tax time.

📌 Table of Contents

• Step-Up in Basis: The Heir’s Golden Ticket
• Does Depreciation Recapture Apply to Inherited Real Estate?
• The Rental Edge Case: When You Use It First
• How the IRS Handles It: Forms 4797 & D
• Real Example: Grandma’s Duplex in San Diego

💡 Step-Up in Basis: The Heir’s Golden Ticket

Under IRS rules, when you inherit a property, your basis becomes the fair market value (FMV) of the property at the decedent’s date of death. This “step-up in basis” means any prior depreciation and appreciation effectively disappear for tax purposes.

Let’s say Uncle Joe bought a property for $100,000 in 1990 and depreciated it down to $20,000 before he passed away in 2022. At his death, it was worth $600,000. You inherit it, and your new basis is now $600,000. Not bad.

That means if you sell it for $620,000, you only owe tax on the $20,000 gain—completely ignoring the $80,000 of depreciation Joe took. Magic? Not quite. But definitely favorable.

⚠️ Does Depreciation Recapture Apply to Inherited Property?

In general, no. You don’t “inherit” depreciation recapture liability. The IRS allows that reset of basis to clear the prior owner's depreciation from your record.

But here’s where many people mess up: if you inherit it and then rent it out before selling, **your own depreciation deductions** start accumulating—and that depreciation *is* recaptured later.

Also, if the property was in use during the time of inheritance (say, tenants were paying rent while probate was ongoing), it’s essential to coordinate reporting between the estate and your personal return.

🏘️ The Rental Edge Case: When You Use It First

If you rent the inherited property even for a few months before selling, you’re starting a new depreciation clock.

This resets the basis to FMV, yes—but the IRS expects you to depreciate from day one of rental use. When you eventually sell, that short rental period might result in some depreciation recapture under Section 1250.

Is it a huge tax bill? Usually not. But it’s enough to cause issues if you don’t report it correctly—and **the IRS loves auditing Schedule E mistakes**.

📄 How the IRS Handles It: Forms 4797 & D

So how does the IRS actually keep track of all this? Mainly through two forms:

• Schedule D – Used to report capital gains or losses on the sale of property.
• Form 4797 – Used if the property was used in a trade or business, like rental.

If you never rented out the property and simply sold it, chances are you’ll just fill out Schedule D and move on. But if you did rent it, even for a short while, you’ll need to report that depreciation and potentially some recapture on Form 4797.

TIP: Always keep copies of the final depreciation schedule from the decedent’s records, even if it doesn’t transfer to your basis. It can clarify things during audit.

🧾 Real Example: Grandma’s Duplex in San Diego

Emily inherited her grandmother’s duplex in 2021. Her grandma had owned the building since 1985 and had been depreciating it for decades.

At death, the FMV was $750,000, and Emily sold it four months later for $760,000 without renting it. Her gain? Only $10,000. No depreciation recapture, no Form 4797—just a straight Schedule D report.

Now imagine Emily had rented it out for three months. Her CPA would need to calculate those three months’ worth of depreciation (probably ~$2,500), and that portion would be taxed at 25% as unrecaptured Section 1250 gain upon sale.

📊 Capital Gains vs Depreciation Recapture: Table Overview

Scenario	Capital Gain	Depreciation Recapture	Form Required
Sold immediately, no rental	$10,000	$0	Schedule D
Rented for 3 months, then sold	$10,000	$2,500 (25%)	Schedule D + Form 4797
Held for 2 years, rented full-time	$40,000	$18,000 (25%)	Schedule D + Form 4797

🔗 Useful Resources for Navigating Inherited Property Taxes

🧠 Final Thoughts: Don’t Let the IRS Haunt Your Inheritance

Inheriting real estate sounds like a stroke of luck—and it can be. But if you don’t navigate the tax rules carefully, especially around depreciation recapture, that windfall might come with a side of tax trauma.

Here’s the golden rule: the IRS gives you a fresh start with the step-up in basis. But once you start using the property—particularly renting—it becomes your responsibility to track, deduct, and eventually recapture your own depreciation.

💬 “The best way to avoid mistakes with inherited property is to slow down, document everything, and get a CPA who actually answers emails.”

This isn’t just about paying taxes. It’s about preserving wealth—and making sure your inherited assets don’t turn into a financial headache.

📌 Quick Checklist Before Selling Inherited Real Estate

• 📄 Get a certified FMV appraisal dated to the decedent’s death
• 🏠 Confirm if there was any rental use before or after inheritance
• 🧾 Review decedent’s depreciation history (for records only)
• 💼 Coordinate with your CPA on Schedule D vs Form 4797 usage
• 📁 Save all documents in a permanent file—audits can go back 6+ years

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