Estate Planning for Rental Property Owners

When you die owning a rental, your heirs' tax basis in it (the cost figure used to measure their gain) generally resets to its fair market value on the date of death, so they can sell at that value without owing tax on the appreciation or on the depreciation you claimed. A rental you give away during your life keeps your adjusted basis, and the person who receives it owes that tax when they sell. For 2026, the federal estate and gift tax exemption is $15 million per person and the annual gift tax exclusion is $19,000 per recipient for gifts giving an immediate right to use or enjoy the property or its income, so federal estate tax applies only when your estate plus your taxable lifetime gifts exceeds $15 million. Some states tax much smaller estates; Oregon's tax starts above $1 million.

Inheriting a rental versus receiving it as a gift

Your adjusted basis is what the property cost you plus improvements, minus the depreciation you claimed or could have claimed. What happens to it depends on how the property passes:

• At death: the heir's basis is the property's fair market value on the date of death, an increase usually called a step-up in basis.
• By lifetime gift: the recipient takes your adjusted basis, plus part of any gift tax you paid, so your depreciation stays built in. If the property is worth less than your basis when you give it, the recipient uses that lower value to figure a loss.

Example. You bought a rental for $300,000 and claimed $100,000 of depreciation, so your adjusted basis is $200,000. The property is now worth $700,000, and your child plans to sell it for that amount.

The gift is also over the $19,000 annual exclusion, so you file Form 709 and use $681,000 of your lifetime exemption, though no gift tax is due until your taxable gifts pass the exemption. If your estate and taxable gifts will stay under the federal exemption and any state estate tax threshold, keeping the rental until death leaves your heirs less income tax than giving it away now, because the gift saves no estate tax. How depreciation recapture works explains the tax on the $100,000, and capital gains tax on investment property covers the rest of the gain.

Three other differences can change the choice:

• A mortgage on the property. If you give away a rental that still has a loan and the recipient takes over the debt, the loan balance counts as an amount you received, so you owe tax on any part of it above your adjusted basis.
• Suspended passive losses. Rental losses you could not deduct under the passive loss rules can never be deducted if you give the property away; they are added to the recipient's basis instead. At death, they are deductible on your final return only to the extent they exceed the step-up in basis.
• 1031 exchange property. The step-up applies to a replacement property you received in a like-kind exchange, so gain you deferred in earlier exchanges is never taxed if you hold the property until death. The 1031 exchange rules cover the deferral itself.

While you still own the rental, tax planning strategies for rental property income covers the yearly taxes.

The 2026 exemption, gift tax returns, and state estate taxes

• Exemption: $15,000,000 per person for 2026, set by the 2025 tax law known as the One Big Beautiful Bill Act, with inflation adjustments starting in 2027. One exemption covers your taxable lifetime gifts and your estate combined.
• Married couples: the executor of the first spouse to die can pass that spouse's unused exemption to the survivor, an election called portability. It is made on Form 706, the estate tax return, due 9 months after the death. The executor must file Form 4768 by that original deadline to obtain the automatic 6-month filing extension. An estate too small to need a return can generally still file one to elect portability until the fifth anniversary of the death.
• Annual exclusion: $19,000 per recipient in 2026 for gifts of a present interest, meaning an immediate right to use or enjoy the property or its income. Gifts to irrevocable trusts must meet this requirement to qualify. Gifts of future interests require Form 709 even below $19,000. Spouses can split gifts to give $38,000 per recipient, but splitting requires Form 709. A larger gift to anyone but your spouse also requires Form 709, due April 15 of the following year. Gifts to a spouse who is a U.S. citizen need no return.

State estate taxes can start far below the federal exemption. Oregon taxes the part of an Oregon taxable estate above $1,000,000 at rates from 10% to 16%, and the tax reaches nonresidents whose estates include Oregon real estate, such as a rental. Check the estate and inheritance tax rules in your home state and in each state where you own a rental.

Community property and the double step-up

How a married couple holds title changes the basis the surviving spouse keeps. When spouses own a rental as joint tenants with right of survivorship or as tenants by the entirety (a form of joint ownership for married couples), half its value is included in the first spouse's estate, so only that half gets a new basis. In the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), the basis of the whole property resets when either spouse dies, as long as at least half of its value is included in the deceased spouse's estate.

Example. A couple bought a rental for $300,000 and claimed $100,000 of depreciation, $50,000 on each spouse's half. It is worth $700,000 when the first spouse dies.

The full step-up applies only to property that is community property under your state's law, so have an estate attorney review how the deed is titled before you count on it.

Keeping a rental out of probate

Probate is the court process for transferring property under a will or state inheritance law. These approaches move a rental outside it, with different tax results:

Probate rules vary by state. California's court self-help guide, for example, lists property in a living trust, joint tenancy property, and property with a transfer-on-death designation among assets that can pass without probate. Before you deed a mortgaged rental to a trust or an LLC, ask the loan servicer whether the loan allows the transfer.

Transfer-on-death deeds. You keep full ownership, including the right to sell or refinance, and the beneficiary gets nothing until your death. Washington's version must be recorded in the county where the property sits before you die, stays revocable until then, and passes the property subject to its mortgage.

Joint title with a child. Buying a rental with your own money and titling it with a child as joint tenants with right of survivorship, when either of you can end the survivorship right, is a gift of half its value, reportable on Form 709 if it exceeds the annual exclusion.

Family LLCs. Holding rentals in an LLC lets you give children membership interests over time instead of deeds, and each gift carries over your basis like any other gift. If you value an interest at a discount because it is a minority or hard-to-sell stake, support the value on Form 709 with a qualified appraisal or a detailed description of your method, because the IRS's time limit to challenge it starts only once the gift is adequately disclosed. Interests you still own at death get the step-up, but in an LLC taxed as a partnership, the rental inside the LLC steps up for the heir's share only if a section 754 election to adjust property basis is in effect. An election from an earlier year continues unless revoked; a new election is made by attaching a statement to the LLC's timely filed return (including extensions) for the year of death. How LLCs are taxed covers the entity's own returns.