The step-up basis tax rule for inherited properties can be criticized as a tax break
for the rich. The Center for American progress declared that a majority of the
financial advantage goes to the top quintile of taxpayers. Some defenders of
the step-up basis posit that this effectively impacts estates with a double dip tax
when the federal estate tax is also considered. During the Biden Administration, a
proposal nearly eliminated the step-up in basis for assets more than $2.5MM, but it
fell through.

Conceptually, when a property gets inherited, the difference between an inherited
NNN property’s revised basis and the amount realized upon sale generates a capital
gain (or loss) that is a taxable event. Thus, a step-up basis reflects the
accumulated capital gain (or depreciation recapture, amortization and depletion) of
an inherited NNN investment.

For instance, an investor who inherits a NNN strip center for $5MM versus the
original purchase price of $3MM creates a step-up in basis. Effectively, the new,
current, stepped up, price of the property eliminates the (taxable) gain
accumulated from time of purchase to time of inheritance. Now, the $5MM price
becomes the cost basis for any future sale, not the original purchase price of $3MM.
(Of course, if the price of an asset has declined from that paid originally, a heir’s
cost basis would step down instead of stepping up.) Similarly, even if the owner of
the property had placed it within a revocable trust, then the heir becomes eligible
for a step-up (or step down) on the basis.

Unfortunately, the unmitigated, uncapped step up basis described above no longer
applies to properties inherited after December 2009. Present tax laws have altered
the cost basis of an inherited triple net lease property to the lower of its tax basis
or fair market value. In other words, the original concept of a “step-up” in basis
may transform into a “step-down” in basis because the lower of two values is
applicable! Furthermore, the capital gain (or depreciation recapture etc) is also no
longer unlimited but capped in dollar value.

Investors should take special note that in states without community property laws,
after the demise of a spouse, jointly-owned property receives only 50% of the
step-up in cost basis vis a vis the 9 community property states.

If you are facing the prospect of an inheritance, especially of a NNN property, allow
our experts at the Triple Net Investment to assist you in the complex considerations
that may call for a purchase or sale or 1031 exchange for maximum tax advantage.
Broker Robert Gamzeh and his team expertly understand the implications of tax
nuances in net lease properties within varied ownership structures.