Step-Up in Basis for Inherited Property in Indiana

When real estate investors learn that you've inherited a property, some will approach you claiming the tax burden from selling it is massive — and offer to take it off your hands at 50 to 70 cents on the dollar to spare you the headache. What they're hoping you don't know is the step-up in basis rule. Understanding it takes roughly five minutes. The financial difference can be tens or hundreds of thousands of dollars.

The step-up in basis is a federal tax rule that resets the cost basis of inherited property to its fair market value on the date of the owner's death. It applies to most inherited assets — real estate, stocks, bonds, personal property — and it can effectively eliminate the capital gains tax that would otherwise apply to decades of appreciation.

What Basis Means and Why It Matters

Tax basis is the starting point for calculating gain or loss when you sell an asset. Ordinarily, if you buy something for $100,000 and sell it for $350,000, you have a $250,000 gain. That gain is taxable — at capital gains rates if you held the asset for more than a year.

For inherited property, the original purchase price paid by the deceased person is irrelevant to your tax calculation. The basis is reset to the fair market value at the date of death.

Here's a concrete Indiana example. A parent purchased a home in Indianapolis in 1978 for $42,000. When they died in 2025, the home was worth $385,000. The heir inherits the home with a stepped-up basis of $385,000.

If the heir sells the home for $385,000 shortly after inheriting it, the capital gain is zero. No federal capital gains tax. No Indiana income tax on the gain. The entire $343,000 of appreciation that occurred during the parent's lifetime passes to the heir tax-free under the step-up rule.

If the heir waits and sells for $410,000 a year later, the taxable gain is $25,000 — the amount of appreciation after the date of inheritance, not the full appreciation from the original 1978 purchase price.

How the Step-Up Works in Practice

The step-up applies automatically under federal law. You don't file a special form to elect it. However, you do need to document the value at the date of death — because that's your new basis, and you'll need it when you eventually sell the asset.

For real estate: Get an appraisal as close to the date of death as possible. A qualified real estate appraiser will produce a written opinion of value tied to a specific date. This is the most defensible documentation if the IRS ever questions your basis. Alternatively, you can support the basis with comparable sales (comps) — documented evidence of what similar properties sold for around the date of death — but a formal appraisal is cleaner.

In Indiana, when you report the sale of inherited real estate on your federal return (Schedule D and Form 8949), you enter the stepped-up fair market value as your cost basis, with the date inherited as the acquisition date. Holding period for inherited property is automatically long-term regardless of how long you actually held it — even if you sell the day after inheriting, the gain is treated as long-term and taxed at the more favorable long-term capital gains rates.

For brokerage accounts and securities: The stepped-up basis applies to each individual security. The date-of-death value for publicly traded stocks and mutual funds is the average of the high and low prices on the date of death. Your broker or the estate's broker should be able to document this.

For business interests, farmland, and other illiquid assets: A qualified business valuation or appraisal is needed. This is especially important for Indiana farmland, which has appreciated significantly over the decades. Farmland that a parent purchased for $300 per acre in 1970 and is now worth $8,000 per acre benefits enormously from the step-up — heirs who sell it at current market value owe nothing on that entire gain.

The Major Exception: IRAs, 401(k)s, and Retirement Accounts

The step-up in basis does not apply to inherited retirement accounts — traditional IRAs, 401(k)s, 403(b)s, and similar pre-tax accounts. This is one of the most important exceptions to understand.

These accounts fall under a tax concept called Income in Respect of a Decedent (IRD). The money inside a traditional IRA or 401(k) was never taxed during the account owner's lifetime — contributions were pre-tax, and the growth was tax-deferred. When the account owner dies, that deferred tax obligation transfers to the beneficiary. The beneficiary pays ordinary income tax on every dollar withdrawn.

There is no step-up in basis for IRD assets because there was no basis to begin with. The original depositor got a deduction for contributions and never paid tax on the income. Giving the heir a tax-free step-up would mean that income was never taxed at all — which is not how IRD works.

For beneficiaries inheriting a traditional IRA or 401(k), the practical consequence is significant. A $400,000 IRA inherited in Indiana will be taxed at ordinary income rates — federal rates plus Indiana's 3.23% flat rate — as you withdraw it. Withdrawals can push you into higher federal brackets depending on your other income. Working with a financial advisor on withdrawal sequencing (spreading distributions over multiple years, coordinating with Roth conversions if applicable) can meaningfully reduce the total tax hit.

Roth IRAs are treated differently. Contributions to a Roth were made after-tax, so qualified distributions remain tax-free to the beneficiary. The step-up question is moot for Roths because qualified distributions were never going to be taxed anyway.

Property Tax Considerations When Inheriting Indiana Real Estate

Understanding the step-up in basis handles the capital gains side. But in Indiana, inheriting real estate also triggers a property tax obligation that many heirs miss entirely.

Indiana's homestead deduction reduces property taxes for owner-occupied primary residences. The homestead deduction is $48,000 for 2025 pay 2026 (dropping to $40,000 for 2026 pay 2027 under SB 1). When the original owner dies, the homestead deduction they were receiving no longer applies to that property.

Indiana law requires the executor or heir to notify the county auditor within 60 days when the homestead deduction no longer applies. Failure to notify triggers a retroactive three-year penalty plus a 10% surcharge — calculated on the back-taxes that would have been owed if the deduction had not been improperly applied.

This notification requirement applies even if you intend to move into the property and re-establish the homestead deduction yourself. The existing deduction dies with the original owner. You must notify the auditor that the prior deduction no longer applies, then file a new homestead deduction claim in your own name once you establish the property as your primary residence.

For heirs who plan to sell the inherited property, the 60-day notification is especially important. Failing to cancel the homestead deduction can cloud the title and create complications at closing when the auditor's records show an improper deduction still in place.

The Indiana Final Tax & Estate Tax Guide at /us/indiana/estate-tax/ includes a deadline checklist covering the 60-day property tax notification alongside all the other time-sensitive obligations Indiana executors face.

Step-Up for Community Property vs. Separate Property

Indiana is not a community property state — it follows the common-law separate property system. This matters for the step-up calculation in married couples' estates.

In community property states (California, Texas, Arizona, and others), both halves of community property get a stepped-up basis when one spouse dies. Only one spouse died, but both halves of the asset benefit.

In Indiana, the step-up applies only to the deceased spouse's portion of jointly-held assets. If a married couple owned a home worth $400,000 in Indiana with each spouse owning 50%, and one spouse dies, the surviving spouse gets a stepped-up basis on the deceased spouse's 50% ($200,000 at current FMV) but retains their original basis in their own 50%.

This is generally less favorable than the community property treatment, which is one reason some long-term planning strategies involve establishing a community property trust for couples with significant assets — but that's a planning consideration rather than an administration issue.

Documenting the Stepped-Up Basis

Get the documentation at or near the date of death, not years later when you sell. Reconstructing asset values after the fact is more expensive and less defensible. For Indiana real estate, commission a formal appraisal within 6 months of death (the IRS accepts a valuation up to 6 months after death using the "alternate valuation date" in certain circumstances, though that election has other tax implications and should be discussed with a tax advisor).

Keep the appraisal report or valuation documentation with the estate records. When you eventually file Schedule D for the year you sell, you'll need the stepped-up basis figure and your acquisition date (date of death).

For Indiana heirs dealing with a mix of inherited real estate, investment accounts, and retirement assets — each with different tax treatment — the Indiana Final Tax & Estate Tax Guide at /us/indiana/estate-tax/ covers the full picture in one place.

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