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So let's say you have a primary residence that was purchased for $50,000 with no money having been spent on improvements and that it's now worth $750,000 according to the tax appraisal district that it's in. If the owner dies and then the property is inherited and the heirs sell immediately they don't have to pay capital gains since the purchase price is, from that point on, considered to be $750,000.

But let's say that a bank appraiser thinks the property is worth $2-3 million instead of the $750,000 the tax appraiser thinks it's worth. It seems like the the capital gains tax break you get is based on what the tax appraiser thinks the property is worth - not the bank appraiser.

My question is... would it be worthwhile to challenge the city's low appraisal of the property near the end of the original owner's life to maximize the capital gains tax break that the heirs of the property might get?

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I think the question is not whether you should use the higher appraisal for determining the stepped-up basis. The question should be: which appraisal is based on Fair Market Value? The FMV on date of death is what the IRS uses to determine any capital gain or loss when the property is sold by the estate or the heirs.

Where I live, the appraised value for tax purposes is loosely based on market prices, but is usually 1 to 2 years out of date. Our most recent tax assessment is at least $100K below the current market prices on our street. I think this is not uncommon around the country. A bank appraiser, who would likely be setting value for the purposes of securing a loan, is much more likely to be looking at current prices, and therefore would be much closer to FMV.

See this FAQ from the IRS.

  • In my area, any sale for a price above the last tax-appraisal price is taken as a de-facto appraisal.... which I have to agree is entirely fair. – keshlam Aug 17 '15 at 21:49
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Real-estate tax appraisals often have very little relation to market value. The estate should get a market appraisal as of the date of death from a competent broker or appraiser. That establishes the tax basis for the heirs.

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