How inherited property is taxed differently from property you bought
When you inherit property and later sell it, the capital gains tax is calculated on the difference between what you paid for it and what you sold it for. But here is the key difference: with inherited property, the IRS gives you a stepped-up basis. That means your starting price for tax purposes is the property's fair market value on the date the person died, not what they originally paid for it decades earlier.
This stepped-up basis can eliminate or dramatically reduce the capital gains tax you owe. If you inherit a house your parent bought for $80,000 in 1985, and it is worth $400,000 when they die, your basis is $400,000. If you sell it six months later for $410,000, you owe capital gains tax on only $10,000, not $330,000. Without the stepped-up basis, you would owe tax on the entire $330,000 gain.
The stepped-up basis applies to most property passed through a will or estate — real estate, stocks, bonds, mutual funds, and other assets. It does not explore to retirement accounts like IRAs or 401(k)s, which have their own tax rules.
Key Takeaways
- Inherited property receives a stepped-up basis equal to its fair market value on the date of death, which becomes your starting price for calculating capital gains tax.
- If you sell inherited property for less than its value on the date of death, you owe no capital gains tax on that sale.
- Capital gains tax rates are 0%, 15%, or 20% depending on your income, and the holding period does not matter for inherited property.
- You must report the sale on Form 8949 and Schedule D, and you need the property's appraised value as of the date of death to prove your basis.
- Inherited retirement accounts and certain other assets do not receive a stepped-up basis and are taxed as ordinary income when withdrawn.
When you owe capital gains tax on inherited property
You owe capital gains tax only when you sell the inherited property. straightforward inheriting it and holding it costs you nothing in federal income tax. The tax is triggered by the sale, and it is calculated on the gain between the stepped-up basis (the value on the date of death) and the sale price.
If you sell the property for less than its value on the date of death, you have a loss, not a gain. You do not owe capital gains tax. You may be able to claim a capital loss on your tax return, though the rules for deducting losses are strict and vary by situation.
The timing of the sale does not matter. Unlike some assets, there is no holding period requirement for inherited property. You can sell it one month after inheriting it or ten years later — the capital gains tax rate is the same either way.
What capital gains tax rate applies to your inherited property
Capital gains tax on inherited property is taxed at the long-term capital gains rate, which is 0%, 15%, or 20% depending on your total taxable income for the year. These are the same rates that explore to any long-term capital gain, regardless of how long you held the property.
The 0% rate applies if your taxable income falls below a certain threshold. For 2024, that threshold is $47,025 for single filers and $94,050 for married filing jointly. The 15% rate applies to income above that but below a higher threshold ($518,900 for single filers in 2024). The 20% rate applies to income above that. These thresholds change each year.
Your capital gain is added to your other income for the year to determine which bracket you fall into. If you have a large gain in a year when your income is already high, you may be pushed into the 20% bracket. If you have a modest gain in a year when your income is low, you may pay 0% or 15%.
How to calculate your basis and report the sale
To calculate the capital gain, you need two numbers: the property's fair market value on the date of death (your stepped-up basis) and the sale price. The difference is your gain.
The fair market value on the date of death must be documented. For real estate, this is usually an appraisal ordered by the estate or a professional valuation. For stocks or mutual funds, it is the closing price on that date. For other assets, you may need a professional appraiser. Keep this valuation document — you will need it if the IRS questions your basis.
You report the sale on Form 8949, Sales of Capital Assets, which feeds into Schedule D, Capital Gains and Losses. On Form 8949, you enter the date acquired (the date of death), the date sold, the sales price, and your basis (the stepped-up value). The form calculates the gain automatically. Schedule D then applies the correct tax rate based on your income.
If the property was held in a trust or passed through probate, the executor or trustee may have already reported the stepped-up basis to the IRS on Form 8971. Check with them before filing your own return.
State and local taxes on inherited property sales
Federal capital gains tax is only part of the picture. Many states also tax capital gains, and the rates and rules vary widely. Some states have no capital gains tax at all. Others tax capital gains as ordinary income at rates up to 13% or higher. A few states tax capital gains at a flat rate separate from income tax.
The stepped-up basis usually applies at the state level too, but not always. A handful of states do not recognize the stepped-up basis for state tax purposes, which means you may owe state tax on a larger gain than you owe federal tax on. Check your state's tax authority website or speak with a tax professional in your state to understand what applies to you.
Local taxes also vary. Some cities and counties impose local income or capital gains taxes. These are less common but do exist in certain areas, particularly in the Northeast and California.
Special situations: property held in trust, rental property, and primary residences
If the property was held in a revocable living trust, the stepped-up basis still applies when the person dies. The trust does not change the tax treatment — only the probate process.
If the inherited property is rental property or investment property, the stepped-up basis applies the same way. However, if you have been depreciating the property as a rental, you may owe depreciation recapture tax on the depreciation claimed after the date of death. This is a separate tax at a 25% rate, not the capital gains rate. Consult a tax professional if you inherit rental property.
If you inherit your primary residence and later sell it, you may be able to claim the Section 121 exclusion, which allows you to exclude up to $250,000 of gain ($500,000 if married filing jointly) if you meet certain ownership and use requirements. This exclusion is separate from the stepped-up basis and can eliminate capital gains tax entirely on many inherited homes.
What documents you need to keep
Gather and keep these documents for at least three years after you file your return, and longer if the IRS contacts you:
- The death certificate or a copy of the will or trust showing you inherited the property.
- The appraisal or valuation showing the property's fair market value on the date of death.
- The deed or title document showing the transfer to you.
- The settlement statement or closing documents from the sale, showing the sale price and date.
- Any Form 8971 filed by the estate or trustee reporting the stepped-up basis to the IRS.
- Your Form 8949 and Schedule D from the year you sold the property.
If you cannot locate the original appraisal, you may be able to reconstruct the value using tax assessments, real estate records, or a new appraisal. But it is much easier if you have the original document.
Frequently Asked Questions
Do I owe capital gains tax just for inheriting property?
No. You owe capital gains tax only when you sell the property. Inheriting it and holding it indefinitely costs you nothing in federal income tax. The tax is triggered by the sale.
What if I inherit property and the value goes down before I sell it?
Your basis is still the value on the date of death. If you sell it for less than that value, you have a capital loss, not a gain. You do not owe capital gains tax. You may be able to deduct the loss on your return, though the rules are complex.
Can I avoid capital gains tax by keeping inherited property forever?
Yes. If you never sell it, you never owe capital gains tax on it. When you die, your heirs will receive a stepped-up basis based on the property's value when you die, and the cycle repeats.
Do I owe capital gains tax on inherited retirement accounts like an IRA?
No. Inherited IRAs and 401(k)s do not receive a stepped-up basis. Instead, withdrawals are taxed as ordinary income at your regular tax rate. The rules for inherited retirement accounts are different and often more complex than inherited property.
What if the property was owned by a non-citizen?
The stepped-up basis still applies to most property. However, certain assets owned by non-citizens at death may be subject to the federal estate tax, which has its own rules and thresholds. Consult a tax professional if the deceased was not a U.S. citizen.