Cost Segregation · Brief · Working level
Step-up in basis and cost segregation: depreciating inherited real estate
Section 1014 resets inherited property's basis to date-of-death value and erases the decedent's depreciation recapture. The heir depreciates the stepped-up basis as newly placed in service — which makes inherited buildings strong cost segregation candidates, though bonus depreciation is barred on decedent-basis property. Partnership real estate needs a Section 754 election to get the same result.
Death is the one event in the Code that erases depreciation history. Under Section 1014, property acquired from a decedent takes a basis equal to its fair market value at the date of death — and the decedent's accumulated depreciation, along with every dollar of recapture it had built up, simply vanishes. The heir does not inherit a schedule; the heir starts one. A building the decedent depreciated to zero over decades restarts at today's value, as newly placed in service property with fresh recovery periods. That reset is why inherited buildings are structurally good cost segregation candidates: there is a full, current-value basis to classify, and frequently no prior study, no old records, and no recapture debt to the past.
One ceiling applies: no bonus depreciation and no Section 179. The used-property acquisition requirements of Section 168(k)(2)(E)(ii) exclude property acquired from a decedent or with a Section 1014 basis, and Section 179(d)(2)(C) bars decedent-basis property as well. The study's payoff on inherited property is shorter regular MACRS lives — substantial, but not immediate expensing.
What the heir actually depreciates
The heir's depreciable basis is date-of-death fair market value (less land), and the property is treated as acquired and placed in service when it begins use in the heir's hands — typically immediately for a rental that keeps operating. A cost segregation study then allocates that stepped-up basis across classes exactly as for a purchase: 5- and 7-year personal property, 15-year land improvements, residual to 27.5 or 39 years. On a $3,000,000 stepped-up building basis with a typical 25 percent short-life allocation, the study moves $750,000 from 39-year straight-line to 5/7/15-year accelerated methods — several hundred thousand dollars of deductions pulled into the first five years even without bonus. The appraisal supporting the estate's valuation and the study should agree on the land/building split; a mismatch between the estate tax file and the income tax file is an examiner's easiest find. Mechanics and conventions are in Pub 946, with the classification standards in the Cost Segregation Audit Techniques Guide.
Two boundary notes. Community-property states double the benefit: both halves of community property step up at the first spouse's death under Section 1014(b)(6). And the step-up runs down as well as up — property worth less than its basis at death steps down, another reason the valuation matters.
Timing: why a study before death can be wasted money
A study accelerates deductions the decedent's estate plan may already intend to erase. For an elderly owner whose plan is hold-until-death, new acceleration mostly converts future step-up-protected basis into current deductions plus a recapture liability that only matters if the plan fails and the property is sold during life. Sometimes that trade is still good — high current bracket, long life expectancy, cash needs — but the default instinct to study every building weakens when Section 1014 is the exit. The better sequence is often: hold, step up, then study the stepped-up basis in the heirs' hands. See what a cost segregation study does for the underlying economics.
Partnership real estate: the Section 754 gate
Most family real estate dies inside an LLC. Section 1014 steps up the outside basis — the interest in the partnership — automatically; the buildings inside move nowhere unless the partnership has (or makes) a Section 754 election. With it, Section 743(b) creates an inside-basis adjustment equal to the heir's step-up, allocated among the partnership's assets under Section 755, and depreciated as newly placed in service solely for the successor's benefit — the other partners' depreciation is untouched. A cost segregation-style allocation of the 743(b) adjustment across asset classes is both permitted and worth doing; without one, the adjustment defaults heavily to long-life building basis.
| Scenario at partner's death | Heir's depreciation result |
|---|---|
| Direct ownership | Full restart on stepped-up basis |
| Partnership, §754 election in effect | §743(b) adjustment; restart on heir's share |
| Partnership, no election | Step-up stranded in outside basis until sale or liquidation |
The election is made with the partnership return for the year of death and is irrevocable without consent; a basis adjustment is mandatory regardless of election only when the partnership has a substantial built-in loss. Executors and successor members should check for the election in the first filing season after death — it is the single largest recurring miss in inherited real estate, and unlike most of the Code's deadlines, this one guards a benefit that costs nothing but paperwork.
Frequently asked questions
- Does inherited real estate get a new depreciation schedule?
- Yes. Under Section 1014, property acquired from a decedent takes a basis equal to fair market value at death (or the alternate valuation date), and the heir treats it as newly placed in service — fresh 27.5- or 39-year recovery periods on the full stepped-up basis. The decedent's accumulated depreciation, and the recapture liability attached to it, disappear. A fully depreciated building can restart depreciation at today's value.
- Is inherited property eligible for bonus depreciation?
- No. Section 168(k)(2)(E)(ii) incorporates acquisition requirements that exclude property whose basis is determined under Section 1014 and property acquired from a decedent. Section 179 is likewise unavailable for decedent-basis property under Section 179(d)(2)(C). A cost segregation study on inherited property therefore delivers shorter MACRS recovery periods — 5-, 7-, and 15-year classes with accelerated methods — but not immediate expensing.
- What does a Section 754 election do for inherited partnership real estate?
- When a partner dies, Section 1014 steps up the heir's basis in the partnership interest — but not the partnership's basis in its buildings, unless the partnership has a Section 754 election in effect. With the election, Section 743(b) gives the heir an inside-basis adjustment equal to the step-up, allocated among partnership assets under Section 755 and depreciated as newly placed in service for the heir's benefit alone. Without it, the step-up sits unusable in outside basis.